In less than 25 years Salesforce (CRM:NYSE) has become a giant of the global software industry and an iconic Silicon Valley name.

Valued at $206 billion, it is the thirty-second largest company on the S&P 500, and according to Fortune’s latest surveys, ranks eighth in the world’s 100 best companies to work for, and eleventh on the most admired companies in the world.

All well and good, but what sort of value has the San Francisco-based company’s stock created for investors? In short, an enormous amount – the shares have achieved a 6,324% total return since listing in 2004. Morningstar data shows that over the past decade the shares have averaged a compound annual return of 18.9% thanks to the company beating analyst forecasts in every quarter for a decade.

Put that into perspective… a $1,000 investment when it first joined the market would today be worth in the region of $64,000 assuming all dividends reinvested. It’s the sort of returns from which millionaires are created and can turn a modest pension pot into a very comfortable one, even for ordinary investors.

But we all know that past returns offer no guarantee for the future, especially when that future looks very different to what has gone before. The era of cheap money is over and most experts believe we will be living with higher interest rates even once the inflation monster has been tamed.

This poses investors with a fundamental question; can Salesforce shares continue to deliver above-average returns in a reshaped economic order, and even if you believe the answer is yes, are the shares priced attractively enough?

WHAT’S THE OPPORTUNITY?

Founded in 1999 by Marc Benioff and Parker Harris, Salesforce is the global leader in customer relationship management software, and it essentially created the Software-as-a-Service model.

Salesforce calls itself the ‘customer company’, providing more than 150,000 clients both large and small with the tools and applications for sales, service, marketing and more.

An estimated 17 million people are thought to be trained on Salesforce products that help teams work better together, create greater understanding of what customers want and need using customer data to provide solutions to real-world problems. Customer 360 is its full-service platform, although various toolkits can be subscribed to separately.

You could call it a niche market, but it’s a very large one – investment bank Goldman Sachs thinks Salesforce’s total market opportunity is around $280 billion. It is also a critical one, particularly for bigger businesses, driving productivity and thus client revenue, and becomes so embedded in operations that it is almost impossible to do without, even in a recession.

As one analyst noted: ‘Salesforce is ingrained in the fabric of so many companies and has become so important in the way they operate and conduct business.’ This is borne out by the fact that its net revenue retention has remained stable at roughly 90% over the past two decades.

Market intelligence firm IDC forecasts that by 2026, the Salesforce ecosystem will create 9.3 million new jobs and create $1.6 trillion in new business revenue worldwide.

Goldman Sachs says infusing artificial intelligence into Salesforce’s core software will bring new opportunities for the firm’s clients, which should further boost Salesforce’s own revenue growth. Overall, the investment bank sees Salesforce’s future cash flow growth as underappreciated, and when its analysts crunch the numbers, they get a 12-month share price target of $325, more than 50% higher than the current $212 level.

GROWTH SPEND NEEDS TWEAKING

At the start of June, Salesforce reported first quarter earnings and revenue that beat expectations and full-year earnings guidance was lifted despite larger project installation dates being pushed back. Yet the shares fell as much as 7% in response, mainly because of rampant costs.

Q1 EPS: 

$1.69 (adjusted) versus $1.61 forecast

Q1 Revenue: 

$8.25 billion versus $8.18 forecast

Source: Investing.com

Capital expenditures in the quarter totalled $243 million, up about 36% and above the $205 million analyst consensus, overshadowing a 1% and 5% beat on revenue and earnings per share respectively.

There is work to do on how much Salesforce invests in its future growth, which is why it has caught the eye of activist investors Elliott Management, Third Point and others, who are demanding that the company takes the scalpel to costs.

Plans to cut its workforce by 10% will help, as will action to reduce its office footprint. More job cuts could be coming, some analysts speculate.

It achieved better-than-predicted operating margins of 28% in the first quarter. Goldman Sachs believes these are set to climb to 30% and beyond over the next few years, thanks to cost-saving initiatives, which have intensified because of the tech spending slowdown and a trending wave of belt-tightening.

This does appear to have impressed some investors, with Elliott no longer demanding its own board representation.

Caught in the crossfire of a debate about growth versus margin protection, challenges await Salesforce. Clients are still looking carefully at deals, which are taking longer to close than they were in the past. Now, the company is looking at how to automate the selling process on the low end of the market and make its salespeople more productive, including the launch of Einstein GPT, Salesforce’s own generative chatbot.

What is Software-as-a-Service?

Software-as-a-Service or SaaS is a cloud-based software delivery model that allows end-users to access software applications over the internet. With a SaaS model, the software is hosted on remote servers, maintained and updated by the service provider, and made available to customers via web browsers, mobile apps and APIs (application programming interfaces). Key benefits include lower upfront costs, scalability, flexibility and accessibility.

Source: Salesforce

ARE THE SHARES WORTH BUYING?

Looking at earnings estimates over the next three years, the stock is on price to earnings multiples of 28.4, 23.5 and 20 for each respective 12-month period. That implies an average PE ratio of 24 for a company growing earnings at an average 27% over the same time frame. The rating looks fair for that kind of growth.

Free cash flow was $4.25 billion in the first quarter, comfortably covering the $1.11 billion interest on borrowings. Salesforce also returned $2.1 billion in the period via share buybacks, although it does not pay a dividend.

‘Salesforce continues to impress, with another strong quarter with revenue and profitability ahead of our expectations,’ said Morningstar analysts following the latest quarterly update. They fine-tuned their model with profitability expectations moving up a bit, offset by slightly lower growth, resulting in an unchanged stock fair value estimate of $245, below Goldman’s estimate but still 16% up from current levels.

‘The shares look attractive especially in light of the modest sell-off in the aftermarket, and the stock remains one of our top picks,’ added Morningstar. Shares agrees that the stock is worth buying.

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