salesforce.com, inc. (NYSE:CRM) is the leader in software-as-a-service (SaaS) computing solutions, which is an industry that is still in its infancy. Through several acquisitions and good internal development, the company has greatly expanded its offerings, and investors and analysts seem to be very optimistic about the future. My concern is that perhaps too much growth is priced in, and that the company won’t be able to produce the kind of profit margins that their investors expect. Is there still an opportunity to get in here, or should investors look elsewhere?
Software as a service, or SaaS, is also referred to as “on-demand software,” and is a delivery model where software and its associated data are hosted on the cloud. This software model has become increasingly popular with enterprises, as it reduces support costs by outsourcing the maintenance and support of the hardware and software to the SaaS company.
Sales of SaaS are currently around $12 billion annually, and are projected to continue growing rapidly, and industry analysts expect around $21 billion in sales for 2015.
A brief history of Salesforce.com
Since its founding in 1999, salesforce.com, inc. (NYSE:CRM) has grown from a single-product company to the leader in SaaS computing. The company now offers solutions for service management, social computing, and market oversight. They have made numerous strategic acquisitions, and a quick check reveals that between 2006 and the present time, salesforce.com, inc. (NYSE:CRM) has made 25 major acquisitions. Most notably is the acquisition of Buddy Media last year for $689 million.
Because of their acquisitions and product development, revenues have grown tremendously over the last decade:
The numbers
salesforce.com, inc. (NYSE:CRM) currently looks a bit expensive, despite the level of growth that is expected. Analysts are projecting sales growth of 27% annually for the next several years, which is a fantastic growth rate to sustain, especially with all of the growth that has already happened.
However, the fact that the company has not managed to convert their existing revenue stream into significant profits is a cause of concern for me. I’m not sure that I’m willing to pay over 100 times earnings for the chance that the company will sustain their high growth rates. salesforce.com, inc. (NYSE:CRM) earned 41 cents per share for fiscal year 2013 (which ended in January) and is projected to grow earnings steadily for the next few years, with $0.79 projected for FY 2016 (calendar year 2015). This translates to an earnings growth rate of about 30% annually, which is great, however that means that the stock still trades at about 50 times 2015’s earnings. That is a bit pricey!
Alternatives
As an alternative to salesforce.com, inc. (NYSE:CRM), consider rivals like Citrix Systems (NASDAQ:CTXS) and Adobe Systems (NASDAQ:ADBE), which offer similar products, however with a more stable record of profitability.
Citrix Systems (NASDAQ:CTXS) is about half the size of salesforce.com by market cap, and has a very similar product and service portfolio, making it possibly the closest comparison. Unlike salesforce.com, however, Citrix Systems (NASDAQ:CTXS) has an established track record of profitability and earnings growth, with $1.86 per share in profit last year. Although the stock trades at a P/E of above 30, that is not necessarily expensive if the growth rate of the company justifies it, which doesn’t really appear to be the case here. According to the consensus, Citrix Systems (NASDAQ:CTXS) is expected to grow its earnings by around 12% annually, which makes the valuation sound a little high.
Adobe Systems (NASDAQ:ADBE) has a much more diverse and well-known product portfolio than the other two with its Photoshop and Acrobat software, which the company has been shifting to cloud and subscription services. As the most mature company here, you may expect it to trade at a more down-to-earth valuation. However, Adobe Systems (NASDAQ:ADBE) appears to be the most overvalued of the three. At 31 times TTM earnings and just 10% growth projected, I would wait for a significant pullback before investing in Adobe Systems (NASDAQ:ADBE).
How to trade it
The cloud computing sector is certainly an expensive one, if you’re looking at current earnings and projections for the next few years. However, this is an industry that is still in its infancy, and the full potential of cloud computing and SaaS remains to be seen. For those adventurous enough to dive in to one of these companies, you may just be getting into the next big thing on the ground floor. Bear in mind though, that there is tremendous risk when investing in a young industry such as this one.
The article A Lot of Potential for Those Who Want Some Adventure in Their Portfolios originally appeared on Fool.com and is written by Matthew Frankel.
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