The stock market did not like the third-quarter earnings report from subscription software giant Salesforce (CRM 1.48%). The company beat analyst expectations, but guidance called for a growth slowdown in the fourth quarter. On top of that lackluster outlook, co-CEO Bret Taylor unexpectedly stepped down effective Jan. 31. The stock closed Thursday down about 8%.
NYSE: CRM
Key Data Points
More concerning than all of this, though, is the splashy $10 billion share buyback program Salesforce unveiled earlier this year. "...we're thrilled to initiate our first-ever share repurchase program to continue to deliver incredible value to our shareholders on our path to $50 billion in revenue in FY26," said co-CEO Marc Benioff in August.
These noncash expenses use a lot of cash
The last thing Salesforce's share buyback program does is deliver value to its shareholders. Normally, share buybacks are a good thing, assuming the price paid for shares is reasonable. After the buyback, profits are spread across a smaller number of shares, boosting per-share numbers and potentially the stock price. In some cases, share buybacks are a better way to return value to shareholders than dividends.
The problem with Salesforce's share buyback program is that it doesn't reduce the share count by much at all. How is that possible? Let me tell you about stock-based compensation.
Like most tech companies, Salesforce doles out equity and options to employees and executives. Stock-based compensation helps retain talent, and it gives employees some skin in the game by tying compensation to the performance of the stock. There's nothing wrong with this in theory.
But also like most tech companies, Salesforce likes to report adjusted profit metrics. These adjusted, or non-GAAP, profit metrics treat stock-based compensation as if it weren't a real expense. While stock-based compensation is a noncash expense, it is very real. Back in 1992, super-investor Warren Buffett had this to say about stock-based compensation:
If options aren't a form of compensation, what are they? If compensation isn't an expense, what is it? And, if expenses shouldn't go into the calculation of earnings, where in the world should they go?
For the current fiscal year, which ends in late January, Salesforce expects to report adjusted earnings per share as high as $4.94. A whopping $3.26 per share will come from the company treating stock-based compensation as something to be ignored.
Here's how this ties back into the buyback program. Even if you were to make the argument that it's OK to pretend stock-based compensation can be ignored because it doesn't use cash, the buyback program uses cash to offset the dilutive effects of stock-based compensation.
$1.7 billion spent
Salesforce spent $1.68 billion on share buybacks in the third quarter. The diluted share count at the end of the third quarter was 1 billion, down from 1.001 billion at the end of the second quarter. Salesforce effectively paid over $1,600 for each share it retired. That's more than 10 times the current stock price.
Salesforce is handing out stock options, claiming that these expenses don't matter by virtue of touting adjusted profit metrics, then turning around and pouring cash into preventing a share count explosion caused by those very same stock options. All the buyback program does is turn a non-cash expense into a de facto cash expense.
Salesforce has more than $8 billion left as part of its share buyback authorization, and more likely than not, the vast majority of that will go toward offsetting the dilution from stock-based compensation. Investors would be wise to ignore Salesforce's adjusted profit figures when evaluating the stock. They're nonsense.
