Is Hubspot Stock the Next Salesforce in the Making?

The past year was rough yet again for cloud software stocks. Facing down the second year of a bear market in which customers got picky with their spending, all the while dealing with new investor demands to refocus on profitability, many apps and software vendors didn't make the cut.

But then there are businesses like HubSpot (HUBS -0.78%). While it's still down significantly from all-time highs, the stock rallied in grand fashion in 2023, and continues to outperform its giant peer Salesforce (CRM 0.42%) over the last three-year stretch (even as Salesforce stock also nearly doubled in value in 2023).

Nevertheless, HubSpot's growth isn't nearly as fast as it used to be, and the business is still a ways off from robust profitability. Can it be the next Salesforce in the making and become a top cloud software provider?

A different era calls for different strategies

Salesforce, founded in 1999, was one of the pioneers of cloud-based software (an app operated from a remote data center and delivered via an internet connection). The company racked up two decades of exceptional growth, augmented by co-founder and CEO Marc Benioff's frequent acquisitions of smaller peers to build the company from a customer relationship management (CRM) app to a full-blown customer data management platform today.

But the cloud is no longer a new industry, and frequent acquisitions to bolster and protect market share (which was helped by over a decade of low interest rates in the 2010s) aren't what investors are looking for these days. Salesforce's pivot to a more mature business that balances slower growth with profit margin expansion is off to a good start.

What that means for HubSpot, founded in 2006, is its playbook won't be the same as that of older Salesforce's -- and it will be tough to reach the $200 billion-plus valuation Salesforce touts anytime soon. Indeed, HubSpot's growth trajectory cooled last year. Revenue for full-year 2023 is expected to total about $2.15 billion, up 24% year over year. By comparison, revenue grew at a 33% rate in 2022.

At its latest investor day update in September 2023, HubSpot management said it will continue to focus on its small-business customers (Salesforce started with big enterprises, and big organizations are still where it gets most of its revenue), but will begin moving upmarket to medium-sized businesses. And along the way, the company will lean hard into new AI tools to help its customers with their marketing, customer service, and digital experience developments and improvements.

Perhaps the growth engine can take it up a notch in 2024. But management's focus at the investor day event was on long-term profit margin targets. In the last reported quarter, adjusted operating profit margin was 16.2%, or negative 3.7% on a generally accepted accounting principles (GAAP) basis. But the long-term target is to push toward 20% to 25% adjusted operating profit margin, with an intermediate target of 18% to 20% by 2026.

But old habits don't die

That isn't to say HubSpot will completely ditch the cloud software playbook of yesteryear. It recently announced it completed the acquisition of start-up Clearbit, a business-to-business data provider to help customers make more informed decisions. Financial details weren't provided, so it was likely a small sum of money paid.

HubSpot has a solid balance sheet, though. As of last September, it had nearly $1.6 billion in cash and short-term investments and another $151 million in long-term investments, offset by convertible debt of $456 million.

While HubSpot makes progress toward positive GAAP profit margins (the biggest drag between this and adjusted operating profit being employee stock-based compensation, at $319 million the first nine months of 2023), it could use its cash to fire up a stock buyback plan. This would offset the dilutive effects of stock-based compensation on shareholders, and would no doubt be cheered by the market's renewed vigorous focus on the bottom line.

Making a change like this has certainly made Salesforce investors happy. Something similar could work the same way for HubSpot.

Is the stock a buy?

The rally in HubSpot last year has the stock trading for a premium again. Shares currently trade for nearly 120 times trailing-12-month free cash flow, compared to about 31 times free cash flow for Salesforce.

Clearly, to justify the premium, HubSpot will need to keep its high-growth momentum going and make some dramatic progress in generating cash from its business. At this juncture, I'd be looking for a significant pullback before I bought the stock right now, especially given the relative value of a lot of other cloud stocks (Salesforce included) that have made a quicker pivot toward delivering the kind of profitability investors want to see.