Valuations Sky High for Cloud Leader

| About:, Inc. (CRM)

It seems like everything I do is done with cloud computing these days. I use the Internet to pay my bills, send letters, do my banking, trade stocks, file taxes and buy books. My local cineplex doesn't even publish movie times in the newspaper anymore. You have to go online to see what's playing and when the show starts.

If you've heard the term cloud computing bandied about and are not sure what it means, it's a very simple concept. Any computer programs you use that require a browser and online access as opposed to residing on your computer's hard drive are considered part of the cloud. It's been around a long time, but for investors, the sector has caught fire the past two years. This is especially true with software for the corporation and rightfully so because this is where a lot of growth is.

According to market research firm IDC, global revenues associated with applications deliverable under a software-as-a-service (cloud computing) model are projected to increase from an estimated $8.1 billion in 2009 to $20.6 billion in 2014. That's a compound annual growth rate of just over 20% for five years.

One such company that is benefiting from this surge in the adaptation of on-demand software is (NYSE:CRM), with its shares rising from $62 to just over $140 in the past year. Make no mistake about it, is in the sweet spot for growth, being a leading provider of sales, marketing and customer service enterprise software. The company also recently acquired Heroku, the leading cloud application platform for next generation social and mobile applications, and, Dimdim, a maker of real time communications technologies. The company has positioned itself well for "Cloud 2," which is the evolutionary progression of software-as-a-service, and should be a formidable company for a long time.

The question is, do you want to buy the stock? The majority of analysts covering think you should, according to Yahoo Finance. Out of the 41 analysts that follow it, 24 have either a buy or strong buy recommendation, while the remaining have a hold rating except for two that give it a sell. After crunching the numbers, I joined the very small minority and also say to take your profits if you own it. Although it's growing by leaps and bounds, its valuations are sky high.

I like to use ValueLine for analysis because I've found them to be fairly accurate throughout the years and will do so for this presentation along with consensus analysts estimates at Yahoo Finance. According to ValueLine, at $140/share, has a trailing P/E Ratio of 291 based on earnings of 48 cents/share for 2010. For 2011, the projected earnings are 75 cents for ValueLine and $1.17 based on the average analyst estimate on Yahoo Finance. This gives it a P/E ratio on the conservative side of 186 and for the median analyst estimate a P/E of 120. That's way too lofty for my blood, but this is a growth stock and you should always take the PEG Ratio (price/earnings/growth) into consideration when evaluating high fliers.

Yahoo Finance has 17.9% growth projected for next year and ValueLine has a compounded annual earnings growth rate for the next 3-5 years at 28%. Let's just call it a 30% growth rate for the sake of simplicity and do the math. At a P/E of 186, the PEG Ratio is 6.2. At a P/E Ratio of 120, the PEG Ratio decreases to 4. That's double or triple what it should be for you to hang on to your shares when using a PEG Ratio of 2 as a sensible point at which to take a profit. I got that PEG Ratio of 2 from Jim Cramer in his book, Jim Cramer's Mad Money: Watch TV, Get Rich, when he was doling out valuation tips. If only he would take his own advice.

On Tuesday, February 8th, Cramer gave a two thumbs up, strong buy on the lightning round segment of his show. I know he's got a lot of stocks to cover, but he's got this one wrong. Standard & Poor's stock report gives a beta of 1.48 and if this market corrects, the stock will go down in value. I wouldn't short it. It's too good of a company, but I wouldn't own it either.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Additional disclosure: Am short the market with inverse ETFs.

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