Andy Kern, Senior Portfolio Manager, New Age Alpha Feb 24, 2020 7:24:00 AM 5 min read Stock Insights

Salesforce (CRM) Stock: A Snowflake in a Market Flurry

Salesforce.com, Inc. (CRM) has been one of the biggest growth stories of the past 10 years and is considered to be the major player in the software-as-a-service (SaaS) business. Investors have become enamored with its consistently growing sales and steadily improving bottom line. The stock is up well over 200% in the past three years, but can the company deliver the results needed to support the stock price?

As Salesforce has gained market traction, the stock has become richer, with investors paying $29 per $1 of expected earnings in 2016 to over $60 per $1 of expected earnings in February 2020. Return-hungry investors looking for an edge are tempted to interpret vague and ambiguous information, such as the future benefits of recent acquisitions, partnerships or market hype. The inaccurate interpretation of this subjective information by investors can lead to stocks being mispriced. This is a risk that we refer to as “The H-Factor.”

In this case study, we examine how the H-Factor explains Salesforce’s stock performance and how likely it is that Salesforce will deliver on its stock price.

Salesforce Is a Big Company Making Big Moves

The stock price of Salesforce has stayed above $180 over the past month. There are many potential drivers for investors sending the company’s market capitalization to over $160B. Over the past decade the company has had a compound annual growth rate of sales of 26%. The company has also captured headlines with high profile acquisitions and partnerships. The public interest that Salesforce subsequently received has made the name a hot topic, making it more susceptible to vague and ambiguous information being impounded into its stock price.

In February of 2020, Salesforce made a strategic private equity investment in Snowflake, a cloud-based technology provider for storing and analyzing data. This investment round valued Snowflake at $12.4B. Given that Snowflake had not been cash flow positive and only recently generated over $100 million in revenue in 2019, investors were left wondering if Salesforce had overpaid for their investment at that valuation.

The Snowflake investment was small compared to the August 2019 acquisition of data visualization software company Tableau. Salesforce spent roughly one year’s worth of revenue - over $15B - on this acquisition. Did they overpay? The stock price has risen more than 20% since the Tableau acquisition. While it is possible that Salesforce’s recent strategy will help the company perform at the levels of the risen price, is it probable? We can find out by analyzing the H-Factor.

 

NAA_Salesforce-01

Price Data: Provided by Yahoo.com/finance as of February 24, 2020
H-Factor Data: Provided by New Age Alpha as of February 24, 2020

The historical H-Factor Information cited above is being provided for illustrative purposes only and should not be construed as providing investment advice or as a recommendation to buy or sell any particular security.

 

NAA_Salesforce_2-01

Price Data: Provided by Yahoo.com/finance as of February 14, 2020
H-Factor Data: Provided by New Age Alpha as of February 14, 2020

The historical H-Factor Information cited above is being provided for illustrative purposes only and should not be construed as providing investment advice or as a recommendation to buy or sell any particular security.

H-Factor Analysis

The run up in Salesforce’s H-Factor to 45% shows that their recent price rise above $180 is representative of runaway market expectations that actual performance is now less likely to support. While an H-Factor of 45% isn’t a flashing red signal, there is less headroom for the company to misstep to rationalize its current valuation. Investors looking for exposure to the SaaS industry may find stocks that the H-Factor System identifies as less likely to miss expectations as more attractive. Adobe (ADBE) and Paycom (PAYC) have H-Factors of 7% and 8% respectively, suggesting that they are far less likely to miss expectations than Salesforce.

From September 2017 through September 2019, Salesforce’s H-Factor remained consistently low. During this two-year period, the rising stock price of Salesforce was not accompanied by a rising H-Factor, meaning that price appreciation was followed by increased performance. Investors may now be too trusting that all propositions for future performance will be successful. The price and H-Factor indicate that investors are accepting higher risk. Specifically, the H-Factor went from 7% to 15% in August 2019 and upwards to 45% in December 2019.

Salesforce’s lofty valuation in tandem with the risk of missing expectations makes it riskier than other companies in the SaaS industry.

The Forecast: Direction Unclear, But Certainly Less Bullish

The Salesforce trade is starting to look crowded, and the H-Factor System sees better value within the SaaS sector. The H-Factor suggests that recent demand to ride Salesforce’s stock on upside potential makes it possible that investors are ignoring risks being baked in underneath the surface. It is more likely now than in the past that the company’s performance will disappoint investors and that investors may be better off getting exposure to Salesforce’s SaaS peers.

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The above statements are not an endorsement of any company or a recommendation to buy, sell or hold any security. Past performance is not a guarantee of future results. The views stated herein are only current through the date stated and are subject to change at any time based on market or other conditions and New Age Alpha disclaims any responsibility to update such views. At the time of this publication, New Age Alpha owns CRM and ADBE. New Age Alpha typically holds securities in its portfolio only if it becomes part of the established universe of eligible securities that are part of each specific investment strategy (e.g. the S&P 500®). It is important to note that there can be no guarantee that the application of the H-Factor to investment portfolios or certain stock or securities can produce profitable results. For full disclosure, click here.

February 24, 2020

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