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salesforce.com Is Cheaper Than You Think

By Ilan Moscovitz | More Articles
September 8, 2010 | Comments (5)

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Here's why salesforce.com (NYSE: CRM  ) is cheaper than you think.

In the daily noise machine of CNBC, analyst estimates, and quarterly announcements, investors are inundated with talking heads obsessing over earnings-per-share figures.

Earnings, or net income, is an accounting construction that is the basis for the price-to-earnings ratio, the most popular way of measuring how cheap or expensive a stock is.

But free cash flow -- the amount of cash a company earns on its operations minus what it spends on them -- is another, oftentimes more accurate measure of earnings that can give you an advantage.

How salesforce stacks up
If salesforce tends to generate more free cash flow than net income, there's a good chance earnings-per-share figures understate its profitability and overstate its price tag. Conversely, if salesforce consistently generates less free cash flow than net income, it may be less profitable and more expensive than it appears.

This graph compares salesforce's historical net income to free cash flow. (I omitted various gains and charges such as tax deferrals, restructurings, and benefits related to stock options.)

anImage

Source: Capital IQ, a division of Standard & Poor's, and author's calculations.

Source: Capital IQ, a division of Standard & Poor's, and author's calculations.

As you can see, salesforce has a tendency to produce more free cash flow than net income.

This means that the standard price-to-earnings multiple investors use to judge companies may overstate its price tag.

Let's examine salesforce alongside some of its peers for additional context:

Company

Price-to-Earnings Ratio

Adjusted Price-to-Free-Cash-Flow Ratio

salesforce

214.4

88.0

NetSuite (NYSE: N  )

N/A

147.3

SAP (NYSE: SAP  )

21.1

20.3

Oracle (Nasdaq: ORCL  )

19.0

14.1

Microsoft (Nasdaq: MSFT  )

11.6

12.9

The purer cloud and CRM players are much more expensive than their blue-chip counterparts; salesforce is certainly no exception.

Nevertheless, salesforce's free cash flow multiple is considerably less expensive than its earnings multiple. While both multiples live up to salesforce's reputation as a pricy stock, salesforce's free cash flow multiple suggests it is much cheaper than many investors think.

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Ilan Moscovitz doesn't own shares of any company mentioned. Microsoft is a Motley Fool Inside Value selection. salesforce.com is a Motley Fool Rule Breakers pick. Motley Fool Options has recommended a diagonal call position on Microsoft. The Fool owns shares of Microsoft and Oracle. Try any of our Foolish newsletter services free for 30 days. True to its name, The Motley Fool is made up of a motley assortment of writers and analysts, each with a unique perspective; sometimes we agree, sometimes we disagree, but we all believe in the power of learning from each other through our Foolish community. The Motley Fool has a disclosure policy.


Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On September 08, 2010, at 11:00 PM, Mstinterestinman wrote:

    So 90 times adjusted earnings for something with a PEG of over 2? i should buy puts this is a time bomb waiting to happen.

  • Report this Comment On September 09, 2010, at 9:13 AM, voxraison wrote:

    very poor analysis. Two things:

    -free cash flow includes employees cashing in their options, an inflow for the company as they exercise options. This is diluting eps into eternity for existing shareholders, akin to the company selling part of itself. You call this operational cash flow? give me a break.

    -cash flow includes cash recd for deferred revenue, ie revenue received for which the COSTS relate to future time periods and hence is accurately deferred to the period for which the cash was received. this is not free cash flow, as the company will have to provide the service in future periods and has received an advance payment.

    Give me a break and do some proper analysis if you wish to make rash statements.

  • Report this Comment On September 09, 2010, at 10:02 AM, martych wrote:

    Might want to do some research yourself. Free cash flow doesn't include cash received from stock option exercises. As far as deferred revenue is concerned, the impact is typically negligible. Amounts in long term don't impact FCF and frequently the amount in current liabilities is offset by a similar amount in receivables. FCF is a far better judge of performance that GAAP EPS.

  • Report this Comment On September 09, 2010, at 11:25 AM, voxraison wrote:

    expenses related to stock based awards:

    42m included in operational cash flow. check your facts.

    payments to salesmen should not be a legitimate cost of business? wages? ok, sure

    Change in def rev balance in last 12m as of 7/10: 69.5m. is this negligible?

  • Report this Comment On September 09, 2010, at 2:26 PM, ElBiotecnico wrote:

    Pardon the typos on the previous note.

    In all seriousness, is this serious? (redundancy on purpose).

    This analysis seems like a feeble justification of what the fundamentals truly indicate ("out of control overvalued?"). Furthermore, indicating that salesforce is "CHEAPER THAN YOU THINK" is just not true. Salesforce is expensive based on pretty much any criteria.

    We are talking about 200+ P/E. That is enormous, and more for a business that (unlike Amazon, with a very high 57+ P/E) does not have as many diverse revenue sources, shown by AMZN EPS of 2.42 vs Salesforce's 0.56.

    So, no, it is not cheaper than we think. It has to be cheap first, and it is not. Too many heads in the clouds...

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