Technology companies can have a high price-to-earnings ratio for reasons that do not make them bad stock buys. In some cases the number can impact the "E" side of the P/E equation, because investing in research and development takes that number down.
Of course, that's not always the case, but it's part of the story for the two companies being talked about in this clip from the Industry Focus: Tech podcast. Analysts Dylan Lewis and Simon Erickson talk about Amazon.com (AMZN +1.10%) and salesforce.com (CRM 0.06%), two companies that have been thriving for years with notably high price-to-earnings numbers. Find out what these companies have been getting right, and why their high P/E numbers are working out for them.
A transcript follows the video.
This podcast was recorded on Jun. 3, 2016.
Dylan Lewis: Let's look at a few examples here. Two from the past that you wanted to highlight. Amazon, a Fool favorite, and Salesforce. Why don't we start off with Amazon? Not a company that was profitable when David Gardner originally recommended it back in 2002. Their top line has grown 25 times since then, which is incredible. It seems like it's moving toward constant profitability. What do you have to say there?
Simon Erickson: What's the P/E today of Amazon? Do we have that number?
Lewis: It's in the 100s.
Erickson: OK. It's still in the 100s even though the company has been around for more than 20 years now. Jeff Bezos' premium, right? This is a company that at first didn't get a lot of attention because they thought they were just spending too much money on the infrastructure to build out this new e-commerce thing.
Then when you start seeing them gaining share, and people keep coming back and back to Amazon over time, that's a different story today. Amazon is still, as you said, 25 times increase in revenue trading at astronomical P/Es, but no one's looking as much at that P/E ratio because there is a lot of faith in Jeff Bezos and the future of Amazon. So, one example right there.
Lewis: Salesforce: actually really not all that different. They weren't profitable when they were originally picked, and despite a massive run-up over the last couple of years, they're still not profitable. I think you're seeing them realize market share, and a lot of the big expectations that are built into the stock, but it seems like the valuations for both these companies suggest there's a huge runway in front of them.
Erickson: That's right, and when we say not profitable, we should specify this is not GAAP earnings profitable.
Lewis: Correct.
Erickson: We're reporting a negative net income even though Salesforce for years has had positive operating cash flow, which is something else we look at a lot in Rules Breakers and Supernova. If you're paying out stock-based comp, if you're depreciating the equipment, those are non-cash charges. We also look at the operating cash flow, and how much is actually going into the company's bank to pay for things like servers or infrastructure and stuff like that. They've been very profitable, by that metric, for a number of years.
Also a very visionary company, I would argue, with Salesforce. They kind of redefined software, especially customer relationship management, which is their kind of specialty in putting it into the cloud. It's no longer going site by site and selling bulky software to companies. It is centrally hosted over the cloud, and that requires a lot of investment up front, but it's also a lot easier for the companies that you're selling to. It's gotten them a lot of wins over several decades now.
