What To Do With Salesforce’s Stock Before It Reports Earnings

What To Do With Salesforce’s Stock Before It Reports Earnings
Carl Hazeley

over 1 year ago3 mins

Mentioned in story

Software giant Salesforce (CRM) is due to announce its quarterly earnings update after the US market closes on Wednesday, which makes now a good time for you to use the new Markets tab to quickly see whether it’s worth buying into.

Value: is Salesforce cheap or expensive?

Salesforce’s stock trades at an enterprise value to sales (EV/sales) multiple of 5x, versus the US stock market’s 3.8x. It’s got a price-to-earnings (P/E) ratio of 33x, versus the market’s 20x. And it offers a free cash flow yield of just 3.7%, close to the market’s 3.9%.

Conclusion: Salesforce’s stock is more expensive than the market, although not by an eye-watering amount. And it could prove attractive if the company’s fundamentals justify its valuation…

Quality: are Salesforce’s fundamentals strong?

Salesforce has grown sales an average of 26% in the past five years – much faster than other US firms, which averaged 7.6%. It’s worth bearing in mind, though, that Salesforce has been a much more acquisitive company than many others, so investors are likely to discount some of that high growth because it’s not necessarily “organic”. And Salesforce’s average profit margin of just 3% in the past three years is way lower than the US average of 18%, and perhaps helps explain the firm’s high P/E ratio.

Conclusion: Salesforce’s impressive sales growth but narrow profits are typical of high-growth tech companies, and while investors have already shown they have less appetite for risky stocks right now, there’s perhaps more to Salesforce than meets the eye, given its relatively high free cash flow yield. In other words, its low profitability isn’t necessarily translating into the high cash investors seem keen to avoid.

Risk: just how risky is Salesforce?

Salesforce’s beta of 1.4 means it tends to move about 40% as much – both to the upside and downside – as the wider market. The stock is more volatile than the market at 50%, versus 36%, which, given it’s a low-margin tech company, is potentially justifiable. But arguably it’s less risky: Salesforce has cash on its balance sheet it can use to cushion itself through the current downturn. US companies on average tend to be slightly indebted.

Conclusion: Salesforce is a risky stock, compared to the wider US market, but it’s got a bit more of a financial cushion than others, which helps balance things out.

Sentiment: what do other investors think about Salesforce?

Investment bank analysts, on average, rate Salesforce’s shares a “strong buy”. But that could be a bad sign: if analysts are already impressed with a stock, it can be hard for it to positively surprise investors. On the positive side, our measure of insider buying is encouraging: execs connected with Salesforce are buying up shares in the company, suggesting they’re feeling more optimistic.

Conclusion: investment bank analysts are hot on Salesforce’s shares, and insider buying activity may be a valuable signal, suggesting execs are feeling positive about it too.

Should you consider buying Salesforce?

Betting on the outcome of a single quarter for any company is binary. But it’s not just a coin toss on whether the company’s earnings and forecast come in better or worse than expected, it’s also gambling on how investors are positioned ahead of the event – i.e. are they “buying the rumor and selling the fact”.

Our Markets tab won’t tell you whether Salesforce is a short-term buy: we’re focused on the long-term. And there, our screen shows Salesforce’s fundamentals and valuation are mixed: there are things to get excited about and things that might give you pause. But with strong sales growth, some profits, a free cash flow yield that’s not too far away from the market’s average, and the margin of safety that comes from the cash on hand, I’m inclined to skew more positively. The fact analysts and insiders are positive on the stock too also is another plus.

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Disclaimer: These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment advisor.

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