Salesforce (NYSE:CRM) is likely the best stock to study to understand why tech equities have recently enjoyed a recovery. In the face of a challenging macroeconomic environment that has put pressure on top-line growth rates, CRM has aggressively advanced margin expansion ambitions, with additional profit improvements predicted in the future. In an effort to shift the stock’s image towards one of profitable growth, management has paired such enhancements with share repurchases. Based on Salesforce stock‘s recent excellent performance, it appears that these efforts are paying off. I reaffirm my buy recommendation for the stock, as the present excellent fundamental performance may result in long-term multiple growths.
CRM Share Price
CRM momentarily fell below 2018 levels until the recent comeback helped it recoup some of those losses.
I last wrote about the stock in January, when I rated it a buy owing to activist activity. Since then, the stock has risen by double digits as the corporation has taken various shareholder-friendly initiatives.
CRM Stock Key Indicators
CRM reported 14% year-on-year revenue growth (17% constant currency) in the most recent quarter, a significant increase over management’s expectation of $8.032 billion in revenue.
Slack did not contribute to the company’s growth this quarter, as growth in that area slowed significantly to 15% year on year, although MuleSoft and Tableau witnessed improved fundamentals.
CRM concluded the year with a non-GAAP operating margin of 22.5%, greatly above the most recent guidance of 20.7%, thanks to a 29.2% non-GAAP operating margin in the fourth quarter. That 29.2% margin was a staggering 1,420 basis point increase year on year. Remember how this is supposed to be a difficult macroeconomic environment?
CRM increased remaining performance obligations (‘RPOs’) by 12%, implying that future revenue growth rates should remain in the low double digits.
CRM had $12.5 billion in cash and marketable securities at the end of the quarter, compared to $10.6 billion in debt.
During the quarter, the firm repurchased $2.3 billion in stock and raised its share-bought authorization to $20 billion.
Looking ahead, management expects 10% YOY sales growth, but the more surprising aspect was the estimate for 27% non-GAAP operating margins, a 450-bps improvement.
On the conference call, management stated that they had previously guided towards 25% margins by fiscal 2026, which means they are exceeding their expectations two years early. Management is now aiming for non-GAAP operating margins of at least 30% in the first quarter of fiscal 2025. This year’s guidance contains, as usual, a high level of conservatism, with management expecting that the protracted sales cycles witnessed in recent quarters will continue throughout the year.
While management appeared to remove their revenue projection for fiscal 2026 of $50 billion owing to “uncertain macro and currency environments,” I imagine Wall Street was more than prepared to ignore that given the tremendous gains to the bottom line. Wall Street expected strong revenue growth when the company was trading at high prices. However, following a valuation reset, Wall Street is now more concerned about earnings, and CRM has demonstrated that its digital business model affords them excellent control over profit margins.
Salesforce Stock: Should You Buy, Sell, or Hold?
These significant increases in profit margins could not have occurred at a better moment. With consensus revenue growth expectations falling from the twenties to the low teens in the coming years, Salesforce stock does not appear inexpensive in comparison to peers, with the company trading at a little under 6x sales.
However, on an earnings basis, that value appears much more reasonable, with the company trading at less than 30 times the forecast earnings.
I’d like to point out that consensus estimates have already factored in CRM missing the prior $50 billion FY26 guidance (consensus estimates call for $43 billion in revenue) and are factoring in only 22% non-GAAP net margins for FY25 (as previously stated, management is guiding for 30% in the first quarter of FY25). Given management’s increasing emphasis on profitability, I consider my previous target of 30% net margins over the long run to be cautious. Even with that same projection, based on 13% predicted growth and a 1.5x price-to-earnings growth ratio (‘PEG ratio,’ CRM could trade at 5.9x sales, implying over 20% potential upside over the next 1.5 years. With CRM consistently expanding margins and buying back stock, I expect more upside to that target as the 1.5x PEG ratio may prove too conservative.
What are the main dangers? While the company’s lofty margin expansion projections for the coming years do not surprise me, I would not be shocked if top-line growth slows quicker than expected. Salesforce has probably maintained an above-market growth rate for many years, owing to costly acquisitions that have given it the appearance of a “growth at any cost” type of organization. While the significant increases in profit margins have successfully generated the image of a profit-minded corporation, given the company’s scale, it may be difficult to sustain rapid top-line growth. At the same time, I might see CRM gaining strength as a result of its diverse product range, since many IT names in my covered universe have emphasized the benefits of comprehensive offers over point solutions.
The management team may be an underappreciated danger. CEO Benioff comes across as unduly promotional at times, in my opinion. He even mentioned in the most recent earnings call that they are “making Salesforce one of the most profitable software companies in the world with one of the highest cash flows and one of the very largest as well.” I can’t remove the nagging notion that Benioff is unduly focused on sustaining the stock’s premium multiple relatives to peers in order to keep the door open for all-stock M&A. Finally, while CRM has recently seen some relative strength, it is probable that Wall Street will begin to give less credit to non-GAAP margin projections, which could lead to significant volatility in the stock price. CRM fits nicely in such a basket due to its profitable secular growth profile, and I continue to position ahead of a tech sector recovery with a strategic basket of inexpensive tech equities. Salesforce stock retains my buy recommendation because of the strong potential for margin surprises.
Featured Image: Freepik @ biancoblue
