Last week, I laid out the case for why investors should give salesforce.com (NYSE: CRM ) credit for its cash-generating prowess, and not instinctively knock the company for its stratospheric P/E ratio. Last week, investors did just that, bidding the shares up 13% on superb earnings news that went a long way toward knocking the P/E down into the, er, troposphere.
Granted, this provider of "on-demand" software to marquee clients like Cisco (Nasdaq: CSCO ) , Google (Nasdaq: GOOG ) , Merrill Lynch (NYSE: MER ) , and ADP (NYSE: ADP ) still trades for upward of 1,200 times trailing earnings, but we could see the valuation drop into the triple digits come 2008 (apologies, but I'm running out of meteorological analogies here.) How's it going to do that? Thursday's earnings news gives us some clues:
- Net profits climbed 19 times higher in Q3 2007 than we saw in Q3 2006, and per-share profits rushed up to $0.05 per share.
- Rapidly rising sales did their part to improve the firm's economies of scale, with revenues growing 48% year over year.
So far this year, salesforce.com is netting a little under 2.1% on its sales. Based on guidance included in the release, to the effect that the company expects more than $1 billion in sales next year, we're looking at $21 million in forward earnings. That works out to a forward P/E ratio of more than 310, which could be even lower if margins continue to improve (remember, salesforce.com was netting negative numbers by this time last year).
More important than the GAAP earnings, though (at least, the way I look at things), was the firm's cash profits performance. Operating cash flow grew 70% to $52 million, while capital expenditures stayed essentially flat at $9.1 million. Result: Free cash flow literally doubled to $42.9 million -- nearly six times what you'd think the firm was earning, judging from its GAAP net income. That brings salesforce.com to $88.3 million in free cash flow for the year, or 51% better than this time, last year -- and eight times its net earnings. At this rate of growth, the company appears to be on track for a valuation of 54 times this year's free cash flow.
For a 51% annual grower, I submit we're now within spitting distance of "fairly priced."
Is it time to grab salesforce.com by the horns, or is this stock ripe for bear-baiting? Watch two of our top Fools duke it out in: