Top 5 Tech Stocks for Fall 2012 - #4
Dave is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Yesterday, at both the Motley Fool and at Fastball Financial, we started our list of Top 5 Tech Stocks for Fall 2012 with Accenture, one of the largest technology consulting companies in the world, at #5. Let's continue the list with our #4 tech stock for this fall.
#4 = SalesForce.com
SalesForce.com (NYSE: CRM) provides customer relationship management (CRM) software through the “cloud,” otherwise known as being accessed via the internet. They have also incorporated a focus on social connectivity within CRM. SalesForce.com is a battleground stock with lots of hype and even more haters. But even the haters cannot deny that SalesForce.com has provided its investors with tremendous returns over the past few years.
There are numerous competitors in the CRM software space. The two most well known competitors are Oracle (NASDAQ: ORCL) and Microsoft (NASDAQ: MSFT), both giants in the software industry. Oracle develops all sorts of software for corporations (application software, middleware and database software). Microsoft develops software for both individual consumers and for corporations. I's main product is still Microsoft Office (Excel, Word, Outlook, etc.), but also produces CRM software, SQL server software, Sharepoint, and Dynamics ERP software, to name just a few. With competitors that large, SalesForce.com has its work cut out trying to become the dominant player in the CRM market. That is clearly the biggest risk to SalesForce's future. Can their product survive intense competition and discounting by larger players? Time will tell, but so far so good.
SalesForce.com is not a cheap stock by any conventional metric. Value investors will mock it as ludicrous. It doesn’t even make a profit. So how does it get a $20 billion market cap?
One way to look at it, a market cap is the collective perception of the present value of expected future cash flows. While SalesForce.com may not show a GAAP profit, they do generate cash flow from their operations. That cash flow is growing...and growing quickly. The chart below shows that while cash flow can be choppy by quarter, the trend is unmistakably positive.
How does this happen? How can they not turn a profit, but generate cash flow? Simple, two things: 1. they get paid up-front on most long-term contracts, so those funds get recorded to deferred revenue and amortized into revenue over the life of the contract and, 2. expenses on the income statement can often include non-cash items. For example, while they provide a lot of stock options for employees, it costs them no cash, but gets recorded as an expense. Net income is important, but cash flow is king.
It’s All About the Revenue
Why else doesn’t SalesForce.com make a profit? They don’t want to. Sound dumb? At first, yes, But look closely at what they spend their money on and why, and it makes perfect sense.
SalesForce.com realizes that to become the leader in the CRM market, it must do everything possible to capture market share and become the standard for customer relationship management. To do so, they have gone all-out on Sales and Marketing spending. In fact, if they cut-back on their Sales and Marketing spend to more “normal” levels, they could be profitable immediately.
But that would be a mistake. Cutting expenses to make profits in the short-term would kill SalesForce.com’s long-term viability. Competitors would quickly gain market share and become the standard that SalesForce.com strives to be. SalesForce would eventually become a niche provider, potentially producing wonderful returns, but nowhere near what they can make as the market leader. Salesforce.com knows that right now, it’s all about the revenue.
SalesForce.com has great revenue growth, a solid back-log in deferred revenue, and rapidly growing cash flow. All-in-all, SalesForce.com looks to be a great long-term investment. In the short-term, you can take advantage of the fact that its stock price hasn’t moved all that much over the past 18 months, despite its increasing revenue and cash flow.
Zaegs owns shares of Microsoft. The Motley Fool owns shares of Microsoft and Oracle and has the following options: short JAN 2013 $150.00 calls on Salesforce.com and long JAN 2013 $150.00 puts on Salesforce.com. Motley Fool newsletter services recommend Salesforce.com. 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.