Since I have learned fundamental analysis and value investing, Salesforce.com (CRM) has been my go-to answer to the question, "Which stocks do you think are the most overvalued?" Although there are other stocks which enter that conversation, like Groupon (GRPN), all of my other sell picks in the technology sector have dropped off big over the past few months. Salesforce.com, on the other hand, has had some very bullish activity over the past few weeks. For those who are short, I will attempt to give my best advice on whether to keep holding on or to cover and accept losses.
At the close of trading on April 12, Salesforce.com traded at $158.30, nearing its 52-week high of $160.12. Every time I have attempted to value the company based on earnings analysis or FCF, I've never reached a valuation higher than $50. Using GAAP earnings, Salesforce.com actually finished its last fiscal year in the red after having three profitable years with GAAP earnings per share peaking at 63 cents. The company famously does include options compensation expense in its earnings announcements, so its results have sounded a little bit more realistic. However, Salesforce.com is a $60 stock at best even when using the non-GAAP numbers.
So where is the value in Salesforce.com? Bulls say it comes from the high cash flow from the subscription nature of the company. It is true that the company has enough subscriptions to stay in business for the foreseeable future. The company had $420.21 million in free cash flow in fiscal year 2012, which has increased by an annualized 35.6 percent over the last three years. Do those numbers really justify a $21.5 billion valuation considering that Salesforce.com still has to deliver on all of those subscriptions? I think not.
For many investors, the question is no longer if Salesforce.com shares are overvalued, but a matter of when they are going to come back down to Earth. This will happen once institutional owners back out of their positions. Salesforce's largest institutional owner is Fidelity, which owns 20.2 million shares or about 14.7 percent of the company. In terms of market value, it is Fidelity's 17th largest investment, right behind Starbucks (SBUX) and ahead of Occidental Petroleum (OXY) and Oracle (ORCL). Of Fidelity's top 40 holdings, it is the 39th smallest company in terms of market cap, with Noble Energy being the lowest as Fidelity's 36th largest holding. As more new tech companies begin to IPO and securities in cloud computing and social networking become more abundant, CRM shares will finally stop an unearned bull run.
I believe much of the hype surrounding Salesforce.com is from supply and demand, which is never a good reason to invest in a stock. From a valuation standpoint, I still believe it is very overvalued, even when playing the devil's advocate and giving it the benefit of the doubt everywhere I could. Right now, I believe the best way to short Salesforce.com is to buy long-term puts in the $90 to $130 range, depending on how bearish you are. This way, there will be a lot of time to wait for the downturn that is way overdue, but still may be a long way away.