Valuation Finally Has Caught up to Salesforce Stock
Cloud giant Salesforce (NASDAQ:CRM) reported robust double-beat-and-raise numbers in its recent third quarter earnings report on Tuesday, 11/28. Yet, despite shares entering the print around 20% off recent highs, Salesforce stock is up just 5% in response to those strong numbers.
In other words, despite Salesforce almost entirely refuting the bear thesis regarding slowing growth and compressing margins with strong Q3 numbers and a strong Q4 and FY20 guide, CRM stock is still more than 15% off recent highs.
Why? Valuation. Salesforce has always been a great growth company. You know that. I know that. The Street knows that. Everyone knows that. That hasn’t changed over the past several quarters, nor will it change any time soon.
InvestorPlace - Stock Market News, Stock Advice & Trading Tips
The secular themes underpinning this company are just too strong and too pervasive to stop.
But, what has changed is valuation and the broader equity backdrop. Rates are going up. The red hot U.S. economy is cooling. A slowing economy amid rising rates isn’t a favorable backdrop for a big growth, rich valuation stock like CRM.
Moreover, fundamentals don’t really support a quick rally back to all time highs. Instead, fundamentals say this stock is fairly valued where it’s trading right now.
As such, Salesforce stock isn’t a great buy here. It was attractive before earnings. But, after this pop, the long term risk-reward profile seems balanced and upside seems good but not great.
Strong Earnings Underscore Secular Growth Thesis
For Salesforce, the Q3 ER was yet another double-beat-and-raise quarter which affirmed the company’s long term growth thesis as a company at the heart of the global cloud and data revolutions.
For the market, it was a strong report that refuted the slowing growth bear thesis and confirmed that tailwinds in those aforementioned secular growth markets remain robust.
Revenue growth once again came in above 20%, continuing what has been a multi-quarter streak of 20%-plus top-line growth. More important, the guide implies this trend will persist for a lot longer.
Next quarter, revenues are expected to rise 25%. Next year, they are expected to grow just over 20%. And, management is maintaining its $22 billion revenue target by fiscal 2022, which implies just under 20% revenue growth in fiscal 2021 and 2022.
Clearly, CRM’s robust top-line growth narrative remains in tact. Global economic trends are slowing, and rates are rising, which could cause growth to slow even more. But, two markets that should be resilient to this are the data and cloud markets because they are of huge importance to enterprises of all shapes and sizes.
Workloads are shifting in bulk to the cloud, and companies are are using data to make informed enterprise decisions. Companies that don’t make these shifts are behind the curve. No one wants to be behind the curve, so demand in these markets should remain robust going forward.
Meanwhile, gross margins continue to track gradually higher towards 80%, while operating margins are improving despite big growth-related investments. The long term implication is for margin improvement to persists, and even accelerate as growth slows over the next several years.
Overall, CRM’s third quarter report was very good. The fourth quarter and fiscal 2020 guides were also really good. All together, strong numbers and a healthy guide imply that this company’s long term growth narrative remains robust.
Salesforce Stock Is Fairly Valued
Despite the strong report, CRM stock is up just 5% as of this writing. A 5% rally on a strong report after a 20% pre-earnings sell-off isn’t all that bullish. The reason for the relatively subdued rally is that around $130, Salesforce stock already is fully valued for robust growth prospects over the next several years.
It seems increasingly likely that Salesforce will hit its $22 billion revenue target by fiscal 2022. Thereafter, growth should remain in excess of 15% due to still powerful tailwinds from the cloud and data markets. Overall, this is a company which realistically has $30 billion revenue potential in five years, or by fiscal 2024.
Gross margins should continue to track higher towards 80%, while the opex rate should continue to fall back towards 55% thanks to robust revenue growth. That combination implies 25% operating margins in five years. On $30 billion in revenue, and assuming a 20% tax rate and some share dilution from stock comp, that should lead to about $6.50 in EPS by fiscal 2024.
Application software stocks usually trade around 30 forward earnings. A 30 forward multiple on $6.50 implies a fiscal 2023 price target of $195. Discounted back by 10% per year, that equates to a 2019 price target of just over $130.
As such, long term fundamentals imply that Salesforce stock is fairly valued at current levels.
Bottom Line on CRM Stock
Salesforce stock is a long term winner, but valuation concerns remain amid a rising interest rate backdrop. As such, while this stock can and will likely head higher from here, it is unlikely to quickly retake all time high levels.
As of this writing, Luke Lango did not hold a position in any of the aforementioned securities.
More From InvestorPlace
The post Valuation Finally Has Caught up to Salesforce Stock appeared first on InvestorPlace.
