Tuesday, September 21, 2010

Salesforce.com's Valuation

The list of stocks with price to earnings of 50x and higher has become pretty long. One example among many is Salesforce.com (CRM).

The market value of Salesforce.com at the recent ~$ 123/share is $ 16 billion.

In the fiscal year ended January 2010 Salesforce.com earned just over $ 80 million.

In the first 2 quarters of this fiscal year the company earned $ 32.5 million.

They are growing revenues and earnings fast and expected to earn ~$ 150-160 million in the fiscal year ended January 2011.

Let's assume Salesforce.com will successfully execute 800% earnings growth in the next 3-4 years and the stock price stays the same. Even if that aggressive assumption becomes real, Salesforce.com's price to earnings multiple would actually still be higher than that of Apple (AAPL) right now.
(Apple is actually a moving target considering its own growth.)

Using the most recent 4 quarters of earnings for both companies:

AAPL: Price $ 283/share, Market Cap $ 259 billion, Earnings: $ 12.23 billion, PE = 21
CRM: Price, $ 123/share, Market Cap $ 16 billion, Earnings $ 73.6 million, PE = 217

So clearly even the 800% growth isn't enough.

I mention Apple, not to compare the two businesses (clearly they are very different), only to give that Salesforce.com valuation some perspective.* Having said that, it seems that some stocks with valuations like Salesforce.com have a tendency to go from what already seems expensive to even more so.

In many instances, the high flyers are transformational businesses with a great story. Some do actually end up justifying the seemingly high valuations in the long run.** I'm not smart enough to get that right very often so, in my case, the losses would almost surely be offset by the gains. It's very likely quite a few folks know how to effectively invest this way but I'm not one of them. Just a completely different game. For me, finding businesses with proven durable competitive advantages and buying them when there is a significant margin of safety is what works.

Salesforce.com may be the making of a great franchise. I've no doubt that there is a great story behind it. The question is:

What are you willing to pay for promise versus what's proven?

Adam

Long position in AAPL

* I'm not a huge proponent of Apple's stock but it looks even cheaper if you take into account the $ 50/share of net cash and marketable securities (nearly 18% of the Apple's market value) it has on the balance sheet. Salesforce.com has less than 2% cash as a percent of market value. In fact, as long-term investments, I happen to be no fan of most tech stocks unless the price compared to a conservative estimate of intrinsic value represents a very substantial margin of safety (i.e. very little has to go right). With too many tech stocks, the problem is that it seems nearly impossible -- using reasonable assumptions -- to create even a very rough estimate of intrinsic value. The range of future outcomes is often just too wide. What today looks like sound core economics often gets destroyed by technological shifts as well as new, very capable, competitors who emerge, sometimes, seemingly out of nowhere. In contrast, the very best businesses have plain durable advantages and a technological/competitive landscape that changes little. When it does change, more often than not, it occurs in a manageable manner; it occurs in a way that the core economics aren't severely damaged.
** Though often the valuations of these businesses disconnect from any kind of likely future economic reality.
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