Here's why salesforce.com (NYSE: CRM) is cheaper than you think.

In the daily noise machine of CNBC, analyst estimates, and quarterly announcements, investors are inundated with talking heads obsessing over earnings-per-share figures.

Earnings, or net income, is an accounting construction that is the basis for the price-to-earnings ratio, the most popular way of measuring how cheap or expensive a stock is.

But free cash flow -- the amount of cash a company earns on its operations minus what it spends on them -- is another, oftentimes more accurate measure of earnings that can give you an advantage.

How salesforce stacks up
If salesforce tends to generate more free cash flow than net income, there's a good chance earnings-per-share figures understate its profitability and overstate its price tag. Conversely, if salesforce consistently generates less free cash flow than net income, it may be less profitable and more expensive than it appears.

This graph compares salesforce's historical net income to free cash flow. (I omitted various gains and charges such as tax deferrals, restructurings, and benefits related to stock options.)


Source: Capital IQ, a division of Standard & Poor's, and author's calculations.

As you can see, salesforce has a tendency to produce more free cash flow than net income.

This means that the standard price-to-earnings multiple investors use to judge companies may overstate its price tag.

Let's examine salesforce alongside some of its peers for additional context:

Company

Price-to-Earnings Ratio

Adjusted Price-to-Free-Cash-Flow Ratio

salesforce

214.4

88.0

NetSuite (NYSE: N)

N/A

147.3

SAP (NYSE: SAP)

21.1

20.3

Oracle (Nasdaq: ORCL)

19.0

14.1

Microsoft (Nasdaq: MSFT)

11.6

12.9

The purer cloud and CRM players are much more expensive than their blue-chip counterparts; salesforce is certainly no exception.

Nevertheless, salesforce's free cash flow multiple is considerably less expensive than its earnings multiple. While both multiples live up to salesforce's reputation as a pricy stock, salesforce's free cash flow multiple suggests it is much cheaper than many investors think.

Ilan Moscovitz doesn't own shares of any company mentioned. Microsoft is a Motley Fool Inside Value selection. salesforce.com is a Motley Fool Rule Breakers pick. Motley Fool Options has recommended a diagonal call position on Microsoft. The Fool owns shares of Microsoft and Oracle. Try any of our Foolish newsletter services free for 30 days. True to its name, The Motley Fool is made up of a motley assortment of writers and analysts, each with a unique perspective; sometimes we agree, sometimes we disagree, but we all believe in the power of learning from each other through our Foolish community. The Motley Fool has a disclosure policy.