salesforce.com (NYSE:CRM) dominates the customer relationship management (CRM) market with its $20 billion of expected annual sales in fiscal 2021. In addition, the coronavirus crisis is likely to have accelerated the transition to cloud computing as enterprises have rushed to implement work-from-home solutions over the last few months, which should boost the company's software-as-a-service (SaaS) businesses.
Yet investors should remain cautious: After its recovery from the market sell-off in March, the stock is now only 10% below its all-time highs. So is it still time to buy Salesforce stock?
Dominant market position
According to research firm IDC, Salesforce dominated the CRM market with a market share of 18.4% during 2019. That's way ahead of its closest competitors, SAP and Oracle, with 5.3% and 5.2%, respectively.
And the company is poised to reinforce its leadership. Management anticipates the CRM market to expand by a compound annual growth rate (CAGR) of 12% over the next few years. In comparison, revenue guidance corresponds to higher revenue growth of 17%.
That success is due to Salesforce's comprehensive cloud-based portfolio, which allows cross-selling opportunities between its different solutions for enterprises to manage their sales, marketing campaigns, human resources, and more.
In addition, since management estimates the company's total addressable market should increase to $174 billion in fiscal 2024, Salesforce still has plenty of room to expand its footprint.
Given its solid revenue growth and strong leadership in its growing markets, the company looks attractive. Besides, its cash, cash equivalent, and marketable securities exceeded its long-term debt by $7.1 billion at the end of last quarter, which isolates it from financial difficulties even if a potentially prolonged recession materializes.
Decelerating revenue growth
Investors should consider Salesforce's strong revenue growth with a grain of salt, though.
During the last quarter, revenue grew by 30% to $4.87 billion, which seems impressive given Salesforce's significant scale. But the company's last several quarters of strong double-digit revenue growth have been boosted by the acquisitions of MuleSoft and Tableau in 2018 and 2019, respectively, for a total of $22.2 billion.
And despite the coronavirus-induced stay-at-home policies that should accelerate the adoption of cloud-based solutions like Salesforce's, management reduced its revenue outlook for the full year to approximately $20 billion, down from previous guidance of $21.1 billion a few months ago. That forecasted revenue growth of 17% represents an important deceleration compared to 29% last year.
Also, investors should pay close attention to the company's investor day in November: Management will update its revenue target for fiscal 2024, which was initially planned to land in the range of $34 billion to $35 billion. That would correspond to an annual compound growth rate of 19.9% at the midpoint based on forecasted fiscal 2021 revenue of $20 billion and without taking into account mergers and acquisitions. But given the significant drop in forecasted revenue this year, that long-term goal now seems optimistic.
Low margins despite the significant scale
In addition, despite its significant scale, the company is still spending about half of its revenue on sales and marketing expenses. Granted, because of the coronavirus crisis, Salesforce had to deal with exceptional costs such as one-time guaranteed commissions, distribution of protective equipment, and event cancellation fees.
But its operating margin, under generally accepted accounting principles (GAAP), was only 1.7% last year. And CFO Mark Hawkins expects non-GAAP operating margin to stay constant this year, at about 16.8%, despite the company's growing revenue base, after having guided for 18.1% during the previous earnings call.
Salesforce stock is not a buy
Based on the forecasted full-year revenue of $20 billion, and assuming strong double-digit revenue growth over the next several years, the company's enterprise value-to-sales ratio of 8.0 seems reasonable.
However, given the midpoint of non-GAAP full-year earnings per share (EPS) guidance of $2.94, the market values the company at a lofty price-to-earnings (P/E) ratio of 59. And that doesn't even take into account some costs that are excluded from non-GAAP earnings, such as share-based compensation. In fact, Salesforce's P/E ratio based on GAAP forecasted full-year EPS is negative, because management expects a GAAP loss of $0.04 to $0.06 per share.
Given the stock's high valuation ratios, the market already prices in strong revenue growth and significant profit improvements. And since the company is struggling to generate GAAP profits despite its dominant position and significant scale, prudent investors should stay on the sidelines.