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StockWatch: Should you buy Salesforce stock? Wall Street is more enthusiastic about smaller rivals Zendesk and HubSpot

Salesforce.com is one of the go-to names in cloud computing, and is also one of the go-to names among companies that MarketWatch readers search for news on.

This quarterly review of Salesforce’s stock will show comparisons between key metrics for the company and its competitors, as well a summary of the most important issues investors are watching right now.

Keep in mind that no two companies are alike — even rivals don’t compete in every space. Any investor needs to do their own research to make informed long-term decisions.

Where Salesforce fits in

Salesforce.com Inc.
CRM,
-0.05%
,
founded in 1999, is one of the 50 largest publicly traded companies in the U.S., valued at more than $200 billion. It’s also recognized as one of the first direct plays on the cloud-computing revolution, as its enterprise software applications allow for flexible and decentralized customer service, automated marketing, business analytics and other services. The San Francisco-based company was added to the Dow Jones Industrial Average
DJIA,
-0.15%

last year.

Since a wide array of enterprises can find value in this kind of customer relationship management — the CRM that accounts for Salesforce’s ticker symbol — there’s a ton of growth potential. Consider that shares of Salesforce have roughly tripled since the middle of 2017, and revenue has doubled since fiscal 2018 (which actually ended Jan. 31, 2018, as the company follows an odd financial calendar).

And broadly, the future continues to look bright for this segment of enterprise software. According to Grandview Research, the global CRM market was valued at $43.7 billion in 2020 and is expected to expand at a double-digit annual growth rate through 2028.

Key metrics

A deeper look into Salesforce beyond these broad trends shows an interesting breakdown of its major segments. These include the regular subscriptions from its enterprise software suite as the main category, but also a smaller business line dubbed “professional services and other.” This secondary segment consists of contracts where Salesforce provides more than software through consultative processes and custom builds based on an individual organization’s needs.

From a top-line perspective, investors may not find this particularly interesting as the vast majority of cash is coming in from software subscriptions. In May, Salesforce posted first-quarter numbers for fiscal 2022 where subscriptions tallied about 93% of total revenue. But the growth rate as well as the gross margins make these specific metrics worth exploring.

Sales growth

Investors should be encouraged by the brisk growth rate in the primary software subscription line as well as the professional services segment that is growing even more quickly.

(Company filings)

(Company filings)

Sure, the services line still has a long way to go to catch up. But it’s perhaps not unreasonable to expect clients who contract directly with Salesforce.com to become “sticky” as they get custom-made solutions they need — and after building them at significant cost and effort, they may be less likely to switch to a competitor anytime soon.

And for the record, professional services at Salesforce are not a loss leader with the hopes of making the cash back via software sales. This business line has been running at or near break-even amid continued growth, which speaks to responsible management instead of simply seeing this segment as a glorified marketing expense that doesn’t have to pull its own weight.

Pricing power and profitability

As evidenced by Salesforce’s segment growth, there’s a lot to be excited about if you’re an investor. But as with any tech megatrend, it’s important to recognize that Salesforce.com is hardly alone in this market.

Adobe Inc.
ADBE,
+0.10%

is an example of a mature software developer that has been investing heavily in this area for years and is seeing a lot of sales momentum in general. However, as most investors probably know, there are a host of offerings this company provides, including editing and design software, that may not be analogous to its CRM-related offerings.

(FactSet)

Among the smaller CRM companies out there, Zendesk Inc.
ZEN,
+0.42%

and HubSpot Inc.
HUBS,
+0.52%

are almost exclusively customer service, marketing and CRM platforms, and this duo is seeing impressive momentum. Salesforce is not alone in enjoying the rising tide in this rapidly growing sector.

Pricing power is more of a mixed bag. Salesforce is in the middle of the pack with margins that lag giants Adobe and Oracle Corp.
ORCL,
+0.53%
.
However, ZEN and HUB are not turning an operating profit at all as they invest heavily in future growth.

Free cash flow

Beyond profits and sales, many investors are interested in cash-flow generation metrics. In a nutshell, free cash flow is how much cash a company is generating after paying the costs of doing business. The value proposition of enterprise software stocks is that they can scale up quickly without a lot of marginal costs, and the larger CRM firms seem to prove this theory out.

(FactSet)

Salesforce is second only to Adobe in trailing free cash flow per share, and second only to Oracle when it comes to total cash on its books with an impressive war chest that now tops $15 billion.

The fact that cash flow per share has improved significantly based on the prior year is a good sign that Salesforce.com isn’t simply chasing new customers at any cost, but instead has continued to prioritize cash flow to drive shareholder value.

Stock valuation and performance

If you’d rather not prioritize cash flow but instead prefer to follow a more traditional valuation model, here are price-to-earnings (P/E) valuations for leading CRM stocks, based on consensus earnings estimates for the next 12 months among analysts polled by FactSet, along with total return figures through June 4.

(FactSet)

Here’s one area where investors may want to be cautious about Salesforce, as the stock trades at a premium over its larger peers when measured by both its forward sales projections and its forward earnings projections. It’s also not particularly encouraging that the stock has lagged behind most of the other stocks on this list in 2021, and over the long term as measured by five-year returns.

Wall Street’s opinion

So, given all this … should you buy Salesforce stock? The official answer on Wall Street, unfortunately, isn’t clear. Here’s a summary of opinion among Wall Street analysts polled by FactSet:

(FactSet)

While 79% rate the stock a buy or better, a bunch of Salesforce competitors have an even higher share of analysts in their corner. Furthermore, while the potential upside is nice based on a consensus target of 19%, that’s half the projected gains of 38% for both ZEN and Pegasystems Inc.
PEGA,
+0.96%
.

These are estimates, of course, and there’s no guarantee any of these CRM providers will deliver. But the lukewarm reception is at least worth noting before you put money in Salesforce stock — or any of its competitors.

Important dates

June 10Salesforce Annual Virtual Stockholders Meeting

— With reporting by Philip van Doorn.

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