Cash Growth From This Cloud King

Chad is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

There might not be a better example of the fact that earnings and cash flow are not the same thing than (NYSE: CRM). I've written in the past about the fact that Salesforce appears to be on a faster growth track than many analysts are currently projecting. The average analyst expects the company's earnings to grow at about 28% over the next few years. However, from the current earnings report non-GAAP earnings per share increased 40%, with revenue increasing 37% in constant currency. In addition, this marked a perfect record of four earnings beats in the last four quarters. However, what earnings per share does not show investors is the strength of the company's cash flow generation. Though Salesforce faces significant competition from large well-established competitors, I've yet to come across a company with similar cash flow generating capabilities.

Salesforce's specialty is helping companies achieve operating efficiencies and get closer to their customer base through cloud computing solutions. Their competitors are companies like Oracle (NYSE: ORCL), SAP (NYSE: SAP), and Microsoft (NASDAQ: MSFT). While each of these companies has their own strengths, none of the three are expected to grow at the same rate as Salesforce. In addition, each of the companies because of their size is more tied to existing products, and is attempting to move their business towards cloud computing. Oracle for instance, is heavily tied to database management software and while cloud computing is a focus for the company in the future, most of their cash generation is from legacy software programs. This is a similar situation at both SAP and Microsoft as each company relies on existing offerings, versus Salesforce which started as a cloud leader and has continued that growth trajectory. To get an idea of the type of growth we are talking about, let's look at the company's most recent earnings report.

Salesforce reported revenue up 34%, or 37% using constant currency. This strong revenue growth followed through to strong bottom-line results, with non-GAAP earnings per share up 40%. The company's two primary divisions both showed significant growth, as Subscription & Support grew by 35%, and Professional Services posted 20% growth. What was equally impressive was the company's growth geographically. Salesforce is still primarily driven by their results in the Americas as 69% of revenues come from this part of the world. In this region, revenue grew 38.44%, but Europe and Asia-Pacific saw strong growth of 22.1% and 28.6% respectively. While these are impressive results on their own, what investors should primarily focus on is the strength of Salesforce's cash generating capabilities.

On an operating cash flow basis, the company generated 64% more cash flow than last year. Even more impressive, was Salesforce's free cash flow growth, which increased 182.16%. These impressive results allowed the company to not only fund its expansion, but also increase their cash and marketable securities on the balance sheet by over 40%. As you can see, while earnings growth is impressive, the company's cash flow growth puts Salesforce in a category of its own. Though the company's valuation on an earnings basis seems high, on a cash flow basis Salesforce represents a good opportunity.

Relative to its competition, Salesforce has a much higher P/E ratio, but also a much faster growth rate. Just for point of comparison, between Oracle, SAP, and Microsoft, all three companies are expected to see earnings per share growth between 9% and 11.6% over the next few years. For investors, Microsoft offers the best dividend yield at roughly 2.6%, and carries the lowest valuation selling for about 10 times forward estimates. While Oracle carries the lowest yield, the company has the highest expected growth rate at 11.64%, and sells for a multiple nearly identical to this rate. I would have trouble recommending SAP as the company neither pays the highest yield nor has the greatest growth rate, but sells for about 20 times forward estimates.

Where Salesforce is concerned, its forward P/E ratio of about 95 surely scares some investors away. However, for a company that grew operating cash flow by better than 60%, and one that is consistently beating earnings estimates, the P/E ratio doesn't tell the whole story. While earnings per share growth is impressive, by examining the company's cash flow statements, investors can see the real growth rate from this cloud leader.

MHenage has no positions in the stocks mentioned above. The Motley Fool owns shares of Microsoft and Oracle and has the following options: short JAN 2013 $150.00 calls on and long JAN 2013 $150.00 puts on Motley Fool newsletter services recommend Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.

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