3 Reasons Why This Tech Stock is WAY Overpriced
Lately, when I look at the price levels of a lot of headline tech stocks, the Prince song "1999" comes to mind. And like the lyrics from that 1982 smash hit, these stocks certainly are partying "... like it's 1999."
Rarely, are pop stars visionaries. Indeed, tech stocks partied hard in 1999, and they were subsequently punished thereafter. The subsequent,hangover has lasted more than a decade... until now.
The names of these high-flying tech stocks have been beaten into investors heads by the financial media on a daily basis: Google (Nasdaq: GOOG), Amazon (Nasdaq: AMZN), Netflix (Nasdaq: NFLX), VM Ware (NYSE: VMW), and of course, Apple (Nasdaq: AAPL). Prices and investor behavior are eerily reminding of those dizzy times.
Another name that's drawn my attention (or ire) is Salesforce.com (NYSE: CRM). The company provides on-demand customer relationship management (CRM) solutions that include soup-to-nuts, scalable, integrated enterprise software, and even cloud services for global blue-chip customers like Avis, Dow Jones Newswire, USA Today, Nokia, and others.
Building a high-quality customer list has helped Salesforce grow revenue by 46% annually during the past five years, from $497 million in 2007 to $1.65 billion last year. For 2012, analysts, with ambitious guidance from company management, project revenue to come in at nearly $3 billion . Most interesting, however, is that with the stock trading near a lofty $142 a share, Salesforce.com has a market cap of more than $19 billion.
We've seen this movie before and the ending ain't good...
I can think of more than a dozen reasons why you shouldn't buy Salesforce.com at these levels. However, I'll share the three most obvious...
The language in research reports covering Salesforce.com is incredibly bullish. A recent report published by Credit Suisse referred to the company as "...an unstoppable force." Company management has provided revenue guidance in a range of $2.92 billion to $2.95 billion, outstripping analyst consensus estimates of around $2.78 billion -- eerily reminiscent of late 1990s, tech-company braggadocio. Whatever happened to "under promise and over deliver?"
2. Valuation rationalization
Salesforce.com's metrics are clearly stretched out and, more often than not, obsessive fans of a certain stock will justify its price and argue why it can and will climb higher.
The most concerning piece of analysis I've noticed in analyst reports covering the stock is emphasis on bookings or contracts that the company has signed, but for which it has yet to actually be paid. Granted, 2012 bookings are projected to come in at $1.09 billion, a 57% increase compared with last year's bookings of $696 million. That's a significant increase, but these numbers haven't even flowed to the top line yet, much less the all important bottom line.
There is value in the pipeline to be sure; however, the company lost $0.09 a share last year. That's a non-existent trailing price-to-earnings (P/E) ratio. The forward P/E is around 70.
Shares trade at a 210% premium to their sector peer group. The first downward guidance from either the company or analysts, and the market will, as always, show that, among other things, it's a voting machine.
3. No moat
The old Warren Buffett tenet of investing in a business with a deep moat (i.e. high barriers of entry) applies here.
Yes, Salesforce.com has a lot of buzz and a decent brand name in the CRM software business. But it's a software business. Theoretically, a college dropout who can write code could build a better mousetrap in their garage.
There are more realistically priced (and underpriced) and proven alternatives in this sector.
Oracle Corp. (Nasdaq: ORCL): One of the greatest legacy enterprise software firms in the business. Shares trade near $30, with a forward P/E of less than 12 times earnings. That's not bad, considering the forward P/E for the S&P 500 is around 13.
SAP Ag (NYSE: SAP): A global leader in the enterprise space for decades, SAP shares trade at about $68, have a forward P/E of 19, which, while a little more than the S&P's average multiple, is still much cheaper than Salesforce's earnings multiple (assuming it even earns money at all this year).
Automatic Data Processing (NYSE: ADP): This company is truly a legend in the information processing world. From payroll to financial services platforms, ADP is a go-to name for small firms and global powerhouses alike. At about $54 a share, a forward P/E of 18 and a historically-rising dividend with shares currently yielding a little less than 3%, ADP is a stalwart name that fits well in any portfolio.
Risks to consider: Salesforce.com shares are clearly overextended and are where the most obvious risk lies. However, investing in a more sensible alternative exposes a portfolio to the risks inherent to the enterprise software business. While the U.S. economy continues to show marked improvement, it's still tenuous. The best way to play defense against these variables is to stick with higher quality names.
Action to Take --> If you own shares of Salesforce.com and have a gain, then congratulations. The market has given you a gift. Take it and say "thank you." If you're considering buying into the hype, then don't. There are better ways to get exposed to enterprise software (the broader sector Salesforce.com is in), and the stocks I mention above are a good place to start your research.
StreetAuthority LLC owns shares of GOOG, in one or more of its “real money” portfolios.