Seeking Alpha

Salesforce.com: This Could Be The 'New Normal' For High-Growth Tech Stocks

|
About: salesforce.com, inc. (CRM)
by: Beulah Meriam K
Summary

Price movement for the past three years has been disproportionate to revenue and earnings growth at Salesforce.com.

Other stocks like NVIDIA and Netflix seem to be going through the same prolonged and cautious price correction.

We might be seeing the 'new normal' in terms of how companies like Salesforce.com are valued.

Salesforce.com (NYSE:CRM) is every investor’s dilemma - until you know what makes the company tick. CRM is a company that invests more than half its revenues into marketing its products and services, spends a lot of cash doing acquisitions that grow its top line, and has never dropped below the +20% level in terms of annual revenue growth rate over the past decade or more. Right now, I believe the market is adjusting CRM’s price due to bloated valuations over the past few years. That makes CRM an attractive long-term buy as the price continues to slide. But there's also an interesting trend that's playing out at CRM and other growth companies in the tech space that I'd like to explore.

So, why are the shares of a company with such stellar performance metrics moving gradually lower for the better part of the past year? In my opinion, there’s been so much upward momentum in the past that the market is finally catching its breath and allowing the stock to settle down to more realistic levels that match its growth rates.

To validate that, let’s look at price movement over multiple periods and compare that with revenue and earnings growth:

Over FY 2017 (year ended January 31, 2017), the stock appreciated 22%, while revenue grew by 26%; in fiscal 2018, the stock went up by nearly 45%, while revenue grew by 25%; in FY 2019, the stock went up by nearly 35% and revenue was up by 27%.

Over the three-year period under discussion, normalized diluted earnings per share grew 76% and revenue grew 57%, but share price grew by a disproportionate 136%.

I believe we’re seeing the after-effects of the market’s enthusiasm during the FY 2018 to FY 2019 period. Since the last annual report period ended January 31, 2019, the stock is down by 6%, and we could see a further downward movement as the market continues to gradually adjust CRM’s price. But don’t wait for it to go much lower than this, because revenue growth moment isn’t going to slow down for the foreseeable future. As it stands, the market still seems ‘hyped’ about CRM’s growth prospects, but the sentiment doesn’t appear to be strong enough to support such high valuations.

From a forward (non-GAAP) earnings point of view, CRM’s current ratios are still at +50 levels, but the chances of those ratios coming down to much lower levels are quite slim. It’s almost as if the market knows that the stock is pricey, but, to a great extent, the continued growth momentum seems to be offering support to the current high valuations. There’s some ‘give’ here, but not enough to make the stock plummet. It’s more of a gentle price reduction until some sort of equilibrium is reached.

The really interesting thing here is that Salesforce.com isn’t the only company where we can see this phenomenon at play. Just look at the one-year price movements of Netflix (NFLX) and NVIDIA (NVDA).

All three stocks have lost ground over the past year, but if you look at the past five-year period, you can see how stock prices have largely appreciated out of proportion to revenue and earnings.

It’s an intriguing trend if you think about it. All three companies are strong growers in terms of revenue and earnings, but all of them have finally arrived at a plateau of sorts in terms of their respective stock prices. I believe these are just temporary plateaux, to be clear, but it represents a significant change in the way the market looks at these stocks.

The key takeaway is that it looks like we have a ‘new normal’ when it comes to how these stocks are valued. A forward earnings multiple of 30+ or 40+ might not necessarily mean the stock is overpriced, especially if it operates in the disruptive technology space and dominates its market segments. That’s certainly the case with Salesforce.com, Netflix, and NVIDIA, all of which are trading at those elevated levels but are now seeing nominal - even cautious, one might say - corrections to their prices. Once the market believes it has achieved the proper quantum of correction for each of these stocks, the prices are likely to continue their climb, but, this time, they’ll hopefully be more accurate reflections of growth in core metrics.

And, that creates an ideal window of opportunity for long-term investors. This article primarily focuses on CRM, but I hope to show similar trends in other growth companies in the tech space over the course of this month. The advantage for investors is that these corrections are prolonged rather than sudden, giving you ample opportunity to get in at the right price. The only thing to keep in mind is that the ‘right price’ might still reflect a higher valuation multiple than ‘normal.’ Despite this, CRM is still worthy of consideration as a permanent member of any long-term holding.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.