Is It Too Late to Buy Salesforce Stock?

Share prices of Salesforce (CRM 0.42%) surged by 9% during after-hours trading on Wednesday after the cloud-based software giant posted its latest earnings report. For its fiscal 2024 third quarter, which ended on Oct. 31, its revenue rose 11% year over year to $8.72 billion, matching analysts' consensus estimate. Its adjusted EPS grew 51% to $2.11, clearing the consensus forecast by a nickel.

Salesforce's growth rates look healthy, but is it too late to buy the stock after its year-to-date rally of nearly 80%? Let's consider why the bulls rushed back to Salesforce and if that optimism is justified.

Image source: Getty Images.

Another quarter of stabilizing revenue growth

Salesforce is the world's largest provider of cloud-based customer relationship management (CRM) services. It also provides other sales, marketing, analytics, and data visualization tools as cloud-based services.

Salesforce's revenue rose 25% in its fiscal 2022 (which ended in January 2022) and 18% in its fiscal 2023. But in its current fiscal year, its growth slowed down as macroeconomic headwinds and fears drove companies to rein in their software spending.

Salesforce splits its cloud ecosystem into five divisions: the sales cloud (24% of its revenue in the first nine months of fiscal 2024), service cloud (26%), platform and other cloud (21%), marketing and commerce cloud (15%), and data cloud (15%) (figures don't come out to 100% due to rounding). 

In the fiscal third quarter, the stabilizing growth of its platform and other cloud (which includes Lightning and Slack) and the accelerating growth of its data cloud (which houses Mulesoft and Tableau) offset the sluggishness of its three other segments.

Data source: Salesforce. YOY = Year over year. Growth is measured on a constant-currency basis.

As a result, Salesforce's subscription and support revenue finally stabilized after its year-long slowdown and its 12% growth in total revenue remained stable from the previous quarter. 

Looking ahead, it only expects a slight deceleration to 10% year-over-year revenue growth in the fourth quarter. For the full fiscal year, it expects its revenue to rise 11%. Analysts expect its revenue to rise 11% in both its fiscal 2024 and fiscal 2025.

That stabilization is encouraging, but Salesforce is growing at a slower clip than many of its CRM competitors. For example, Microsoft's Dynamics revenue grew 26% year over year on a constant-currency basis in its latest quarter. HubSpot, which provides simpler CRM and marketing tools for smaller businesses, also reported 26% year-over-year revenue growth in its latest quarter.

Its margins are still expanding

Salesforce's revenue growth is cooling off, but its aggressive cost-cutting strategies -- which included laying off thousands of people, reducing its marketing expenses, and suspending its ecosystem-expanding acquisitions -- significantly boosted its adjusted operating margin, free-cash-flow (FCF) margin, and adjusted EPS over the past year.

Data source: Salesforce.

Salesforce expects its adjusted operating margin to rise from 22.5% in fiscal 2023 to 30.5% in fiscal 2024 as its full-year FCF rises by approximately 33% to 36%.

Those bottom-line improvements convinced the activist investors who had besieged the company earlier this year to finally back off. But over the long term, its conservative spending strategies could gradually erode its defenses against Microsoft and other heavyweight challengers in the cloud-based enterprise software space.

Salesforce expects its adjusted EPS to grow by 34% to 35% year over year in the current quarter and to rise 56% for the full fiscal year. Analysts had only expected its adjusted EPS to grow 42% for the full fiscal year and to rise 21% in fiscal 2025.

Is it too late to buy Salesforce's stock?

At around $250 today, Salesforce trades at 31 times its projected adjusted EPS for fiscal 2024 and 28 times analysts' EPS estimates (which will likely be raised) for its fiscal 2025. Those valuations aren't cheap, but they still seem reasonable relative to its earnings growth. Microsoft, which is growing at a slower rate, trades at 34 times forward earnings.

Salesforce might attract more bulls as its margins and earnings continue to expand, but I'm concerned about its slowing revenue growth. If it reins in its spending too aggressively as the macroeconomic environment warms up again, it could lose customers and throttle its own revenue growth. So for now, I'd avoid Salesforce until it gives investors a clearer sign that it can revive its sales growth and isn't merely burning the furniture to stay warm and impress its more myopic investors.