Noted hedge fund manager Thomas Steyer’s Farallon Capital holds a diversified portfolio of large, established stocks with a focus on technological innovation.
Farallon has taken a position in Salesforce (NYSE:CRM), one of the world’s largest business software companies.
The fund has a position of over $500 million in CRM shares, making it the sixth largest holding. So what is it about this SaaS company that has compelled the fund to take such a large stake?
Salesforce Is Dominant Yet Has Room To Grow
As a company, Salesforce is in the admirable position of leading a market that is still expanding. The company enjoys a nearly 24% share of the CRM software market, and it continues to grow among large, enterprise-scale businesses.
An estimated 90% of Fortune 500 companies use Salesforce, giving the company a massive edge when it comes to retaining high-value customers.
At the same time, Salesforce is still growing reasonably well as businesses continue to invest more and more in digital tools. Although revenue growth has slowed in the past three quarters, it’s still over 11% on a year-over-year basis. The company has also been remarkably consistent in its expansion, as it hasn’t experienced a single quarter of negative revenue growth in the last decade.
Turning to net income, Salesforce has been less consistent, but the trend is still moving in the right direction. In the past two years, the company has been profitable in all but two quarters.
The most recent two quarters have also been among the company’s best where profit is concerned. Salesforce reported over $1.2 billion of net income in each of them. The only quarter in which the company was more profitable was Q2 2020, in which Salesforce generated a net income of $2.6 billion.
Even more importantly, Salesforce appears to still have a long growth runway left ahead. In the forward 12-month period, for example, analysts expect CRM’s revenues to grow by a further 13.4%.
As the company’s profitability stabilizes, earnings growth are forecast to continue at a high level. Earnings per share are projected to advance at nearly 25% annually over the next five years, a trend which in conjunction with continued revenue growth is very likely to put further upward pressure on Salesforce shares.
Salesforce Could Get a Boost From AI
Though Salesforce established its market leadership as businesses were pursuing much more traditional digital transformations, the company also stands to benefit from innovation in generative AI.
Within Salesforce’s Slack messaging and collaboration platform, for example, AI is being used to help users rapidly find relevant information on projects.
Salesforce also offers an AI app platform known as Einstein which gives Salesforce customers the ability to build proprietary AI applications for their teams and customers. These apps can streamline tasks by recommending actions for team members, identifying patterns in business data and deriving insights from human-generated text. With businesses increasingly turning to AI, Salesforce’s positioning in this space have the potential to really set the firm apart.
Salesforce Continues to Perform Well
At this point in its history, Salesforce is putting an increasing focus on delivering stable, sustainable profits to its shareholders.
The Q3 earnings report demonstrated management’s general success in this effort. In addition to 11% year-over-year revenue growth, Salesforce achieved a GAAP operating margin of 17.2% and reduced its cost of revenue to $109 million from $130 million in the year-ago quarter. These changes point to fundamental improvements in efficiency that could continue to bolster shareholder returns going forward.
As noted above, Salesforce also drove significant earnings improvements in Q3. Net income per diluted share totaled $1.25 against just $0.21 in the same quarter last year. Management projects similar earnings per share in Q4, with full-year earnings of around $4 per share.
For a fast-growing tech firm, Salesforce also generates a decent level of profit from its revenues. The company’s net profit margin over the past 12 months has been 7.6%, and its return on equity has been 9.2%. Though certainly not overwhelming, these margin numbers are likely to improve as the company continues to focus on improving profitability.
Valuation Could Be Salesforce’s Downside
In spite of good performance and a very solid competitive position, Salesforce suffers from the same kind of optimistic valuation that plagues many tech stocks in today’s market.
At this time, Salesforce trades at 9.0x sales, 36.3x cash flow and 48.4x projected forward earnings. These multiples could make the stock more susceptible to downward corrections if growth slows or the company encounters unexpected headwinds.
It’s important to note that CRM has a couple of key advantages over some other heavily valued tech stocks. To begin with, the company is already achieving a respectable level of profitability, making it a bit less speculative. Where many high-growth tech stocks are competing for dominant positions in emerging parts of the market, Salesforce already has an established moat around it. As such, it may be able to sustain a high valuation better than many other companies.
Is Salesforce a Buy?
There is little doubt that Salesforce trades at a premium, but the overall quality of the business does much to offset the risk of high pricing. Barring significant disruption, Salesforce is likely not in any danger of losing its grip on the customer management software market. With profits growing and revenues continuing to increase, it’s likely that Salesforce still has a bright future ahead of it.
That said, investors could face short-term stagnation due to the already high price of the stock. CRM shares currently trade at $289.72, and the median 12-month price target for the shares is $287.50. With enthusiasm for AI innovation seemingly beginning to reach its logical limits in pushing stocks higher, it’s possible that CRM could be in for a slower year ahead.
Ultimately, Salesforce appears to be a moderate buy. The stock may not deliver stellar returns this year, but long-term trends and the company’s improving earnings both appear to be significant tailwinds for share prices. Over time, the company will likely continue to appreciate in value as margins increase and businesses invest in tools to generate more value from customer data.
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