Many investors are probably not aware of the nature of Salesforce.com’s earnings. Sometimes they might even be surprised by the incredible discrepancies reported on the media regarding those same earnings, with an article talking about how Salesforce.com trades at 100 times earnings, while the following one reports 600 times.
What happened here is that Salesforce.com, as it saw its GAAP earnings peaking, decided to start highlighting a new, non-GAAP, measure (as can be seen below). Now, non-GAAP exists because sometimes one-off events, non-cash charges, goodwill write-offs and other non-recurring situations distort the earnings being reported according to GAAP rules. So, as a way of making life easier for investors, companies sometimes go the extra length and report earnings without those effects, hence, non-GAAP.
However, such is a fertile ground for malfeasance, and some other companies, seeing that they could ignore a few costs and present a better picture to the investors, leading to higher valuations, have started abusing the practice. Salesforce.com is one of them.
Salesforce.com's Change of Heart
Fiscal Q4 2010
“Q4 GAAP EPS of $0.16, up 41% Year-Over-Year”
Fiscal Q1 2011 starts non-GAAP as GAAP peaks
“GAAP EPS of $0.13, down 13% Year-Over-Year;
Non-GAAP EPS of $0.30 rises 7% Year-Over-Year”
Imagine for a second that Salesforce.com was not selling/renting CRM (Customer Relationship Management) software, and was instead running a lemonade stand, which by virtue of chance had its shares quoted in the stock market.
Now, this lemonade stand sells lemonade at $1 a cup, and is doing brisk business because it sells it in a new kind of cup, but also because it keeps a small army of strongly incentivized salesmen. That army of salesmen, though, doesn’t come cheap, and between the costs of the product itself, and the compensation paid to them, each cup costs $2 to make.
So, here is CRM selling lemonade at $1 a shot, and having costs of $2 each time it makes a sale. How much profit are they making per each cup sold?
And if CRM, seeing the financial image problem the answer carries, suddenly decides to pay the salesmen in stock, so that $1.20 of each cup’s $2 cost is paid in stock, how much is CRM now making in profit?
According to CRM’s “cloud accounting,” it's now making $0.20 per cup! This might seem strange, but is a true description of CRM’s non-GAAP earnings. For instance, in the last reported quarter (July 2011, fiscal Q2 2012), CRM reported $0.31 EPS per share. Of these, how much came from ignoring stock-based compensation? $0.38 ($55 million on 143 million diluted shares).
Also, investors should take notice that for a company trading at an extraordinary valuation, CRM’s “cloud earnings” have actually been the same since fiscal Q4 2010 (that’s 7 quarters ago). It is stuck at $0.28 - $0.32 a share since - and remember, these are the fake earnings, the GAAP number has already turned negative (though GAAP paints too much of a negative picture here, as some goodwill charges really should be ignored). Anyway, here is a company having basically no earnings growth for 2 years, and still trading at a PE of 600 (based on GAAP earnings).
Disclosure: I am short CRM.