Salesforce Stock has already started its next rally (NYSE: CRM)
I’ve made it pretty clear over the past few weeks – both in my public posts and for subscribers – that I think rock bottom has already been reached. areas that have been wiped out this year – are going to get us out of this bear market. This belief has led me to shop around for risk exposure over the past two weeks, and one area that I think looks great is software.
I see a lot of charts that I like in software, but the one that I think has a great chart and a very strong future from a fundamental standpoint is software conglomerate Selling power (New York Stock Exchange: CRM). This company has been and will likely remain a leader in the field through transformational acquisitions and organic growth, and the chart tells me the time to buy is near. I informed subscribers on June 2n/a that I thought CRM had done the down, and so far so good. But it’s not too late to buy, as the action since I made that call has only reinforced the idea that the path to CRM is higher from here.
There’s a lot going on with this chart, so let’s look at the most important thing first, and that’s the price action itself. We can see that the big rally in the earnings report came to a halt exactly where you expected it to, in the resistance zone I marked. It’s no coincidence, and that’s why I like to use technical analysis. Since then we have seen a few setbacks and a few failed rally attempts. However, there are plenty of reasons to be optimistic right now.
First, we see higher lows. This means that the sellers have already reached exhaustion or are very close. Second, momentum indicators are pointing up and have been for some time even as the stock flounders. This, again, is quite bullish as it indicates that the sellers are drying up.
In the bottom two panels, we can see that Salesforce has been outperforming its peer group since early June, and critically, software stocks are starting to outperform the S&P 500 again. We want to own winning stocks in winning groups, and to My eyes, Salesforce ticks that box.
Finally, the 20-day EMA and the 50-day SMA rose, which is a critical step in the bottoming process. These should now act as support, after several months of resistance.
I see a whole lot to like here from a bullish perspective, and basically nothing that makes me bearish. It looks like Salesforce has been punished enough in the last eight months or so and the next bull run has begun.
Now let’s look at the fundamental case of Salesforce, because I think it’s just as compelling.
Growth, both purchased and manufactured
What I love about Salesforce is that it’s extremely diverse, which is the exact opposite of most software stocks. Typically, software stocks have one product, or maybe a main product and extensions of that product. The fact is, however, that when a new competitor starts doing the same thing, it can be devastating for a highly focused business. Software is the antithesis of that, and its diversification is perhaps its most appealing trait.
The last fiscal year saw growth of at least 15% across all of its categories, with MuleSoft and Tableau leading the way in revenue growth. You wouldn’t know from looking at the stock price that the segments of the company were all crushing it in terms of generating new business. The stock price looks like a company in decline, but that couldn’t be further from the truth.
Additionally, the company’s backlog continues to grow and is absolutely huge at this point.
Salesforce ended the first quarter with an RPO of $42 billion, up 20% year over year. This represents approximately 16 months of revenue in the backlog, and it continues to grow as revenue increases. This ensures that Salesforce remains in a strong position from a revenue growth standpoint for the foreseeable future, which is critical given how much money the company is spending.
Salesforce touts its workplace rewards, and rightly so; attracting the best talent is a goal that every company wants to achieve. However, headcount grew 30% year-over-year in the first quarter and has grown extremely rapidly in recent years. While this supports innovation, product development, and ultimately growth, it’s also the most expensive thing a business can do.
Salesforce, despite its enormous size, continues to invest like a startup in its future growth. As long as it pays off, this strategy works. If not, Salesforce will have a gigantic fixed cost base with no commensurate revenue or margin to pay for it. To be clear, I don’t think that will happen, but when you see headcount significantly outpacing revenue growth, that’s something that needs to be watched. There is such a thing as overinvestment.
Going back to the revenue story, below we can see Salesforce’s history of top performance estimates, which is evident by the almost constant upward slope of these lines.
There are dips as sentiment changes over time, but the trend here is pretty clear. In addition, there is enough space between the lines, which represents year-on-year growth. Not much to say here except that if you’re looking for reason to be optimistic, you can do a lot worse than seeing earnings revisions like this.
We see a bumpier road with EPS, which looks totally different from the earnings revisions we just looked at.
The trend is even higher over time, but there was huge Salesforce expectations at the end of 2019, just before the start of a certain pandemic. Since then, estimates have bottomed out before rising again for this year, as well as for the next two years. The coming years continue to see downward revisions, but these are much smaller than expected for the next year or two. On this metric, it looks like Salesforce had the worst of it all, which is another key factor in spotting a bottom.
A final point before coming to the assessment is that Salesforce has largely made its living buying growth. Its shopping list is long and the company has spent huge amounts of money over the years buying businesses to add to its ecosystem.
Over the past few years, over $20 billion in cash has been paid out for acquisitions. That’s a huge amount for all but the biggest companies in the world, but to its credit, Salesforce has maintained an impeccable track record throughout.
Net debt has fluctuated, as expected, but has a very good chance of being around zero by the end of the July quarter. This means that Salesforce has immense flexibility with its own business to invest in, but also to go out and get its next bolt-on goal to further build its ecosystem. I see the lack of leverage as a big plus for Salesforce given its chosen buy growth strategy, and it supports the bullish case over time.
To be fair, Salesforce isn’t exactly afraid of diluting shareholders both to pay employees and to fund these acquisitions. However, as long as they’re accretive, that’s okay. For now, it’s working.
As you might expect, a stock that has halved from peak to peak now looks much cheaper than it used to. Let’s start by evaluating it on a price-sales basis.
This is a three-year view, and we can see that the trough was 4.8x sales, which was actually reached very recently, while the peak was 11.4x. I don’t think we’ll see this kind of assessment anytime soon, as unbridled bullishness is needed for such foam. However, the average of 7.9X? Absolutely. The past two years have proven that the Salesforce model isn’t broken and is, in fact, thriving. Why shouldn’t we expect at least an average valuation?
Now let’s take a look at the forward P/E, which shows an even more bullish hue.
The average forward P/E over the past three years is 60 times earnings, and stocks are trading for only 35 times today. Again, the 84X peak is probably unrealistic, but we could easily see 50X to 60X forward earnings in the coming months, given that I think the stock has bottomed out. That would mean a share price of $238 to $286 on $4.76 of projected EPS for fiscal year 2023, and if we do the same calculation on fiscal year 2024, we’re looking at $292 to $350. If you keep the score at home, it’s a long way from the current price of $176, so I think the short and long-term upside potential is significant to say the least.
Buying software stocks in the face of a recession, and while we’re still in a bear market, takes a bit of faith to be sure. But I see signs everywhere that there is room for optimism, which is why I told my followers five weeks ago that it was okay to buy CRM. I still see that as the case now, with the last five weeks having reinforced the bullish case.
Salesforce is far too cheap and has far too much growth to come to be priced as is. This stock is going much, much higher.