What happened
Salesforce.com (CRM 1.27%) stock fell 10.8% following a disappointing earnings announcement on Nov. 30. While the company outpaced Wall Street estimates for revenue and earnings, analysts were dissatisfied by its growth outlook.
So what
Salesforce.com reported 27% revenue growth in its most recent quarter, which was more or less in line with analyst expectations. The company produced a small net profit and was free cash flow-positive. There's typically a tradeoff between profitability and a high growth rate, so investors are generally pleased when a stock can deliver both. The company also reported 23% growth in remaining performance obligations, which is a popular metric for software companies that measures bookings for future periods. That suggests that its elevated growth rate will continue, but it could slow down slightly.
That potential slowdown is exactly what weighed on the stock. Salesforce.com issued guidance for the final quarter of its fiscal year, and those forecasts suggest a slight slowdown. Its adjusted EPS outlook fell well short of Wall Street estimates, too. The company expects operating margin compression because of higher employee expenses and costs related to sales and marketing.
Growth stocks are susceptible to large drops, especially in the current market conditions. Low interest rates and general capital market dynamics over the past two years have sent many software stocks to unsustainably high valuations. The Federal Reserve's accelerated tapering timeline and rising interest rates should create a headwind for the stock market in general, and those expensive growth stocks in particular. It's normal to see heightened volatility at this portion of a market cycle.
Image source: Getty Images.
Now what
The recent struggles of Salesforce.com stock is a tough pill to swallow for shareholders. If we zoom out, though, it looks like a short-term correction that brings the stock back to its long-term upward trend. It's still up around 70% from the COVID-19 market crash low, and now it has a much more rational valuation with a strong fundamental upside.
Salesforce.com is a high-growth tech leader with a wide economic moat. It's a solid business that isn't going away anytime soon. The issue comes down to valuation. Its forward P/E ratio is still around 50, despite tumbling more than 25% over a tough couple of months. That's nothing too crazy for a free cash flow-positive company that's growing 25%-30% annually. That places its PEG ratio at a reasonable level around 2.
Salesforce.com is an enticing stock for long-term investors. Like most growth stocks, it runs the risk of high volatility in the short term. It probably shouldn't make up too much of your portfolio if you're a retiree or otherwise risk averse. It's a much stronger candidate for a Roth IRA for investors in their 40s or younger.
