A first look at Salesforce; ODP soars on acquisition news; My first ride in a Waymo
1) Last week, two of my readers put another stock on my radar...
I'm talking about software titan Salesforce (CRM).
First, as Daniel F. wrote:
Can you do an analysis on Salesforce stock? It's a business that produces lots of free cash flow, sticky customer base, double-digit earnings growth and trading under 20x forward earnings. Curious to see what you think of the business and the current valuation. They recently upped their authorized buyback to $50 billion – pretty significant.
And as Bob L. wrote:
Salesforce appears to be a solid company but the stock price is down approximately a third from its high. I know my company (and many others) utilize their customer relationship management products. Their products are well entrenched.
I once owned the stock and was fortunate to get out higher. Wondering if it's time to get back in or am I missing something and this is a falling knife?
I'm intrigued. So today, let's check out the stock with my usual "first look" analysis...
For some context, Salesforce has been one of the greatest growth stocks of all time.
It rose nearly 100 times from when it went public in 2004 to its intraday peak of $369 last December. But since then, the stock is down 33% to this past Friday's close of $247.09. Take a look at this long-term stock chart:
The company has grown revenues at a consistently high rate over the past two decades. But until 2021, it was barely profitable. It generated cumulative operating income of about $2.5 billion over 17 years from 2005 to 2021.
But since then, profits have exploded. They reached about $8.4 billion over the past 12 months. Take a look at this next chart:
I can't recall ever seeing a revenue and profit chart that looks like this.
But free cash flow ("FCF") is exactly what I expected to see. The company has very low capital expenditures ("capex") – which is consistent with a software business. And operating cash flow and FCF have risen steadily, in line with revenues. This next chart tells the story:
So why was profitability so low for so many years?
In part, that's because Salesforce invested heavily in growth and made many acquisitions using stock.
But the main reason is that the company relied heavily on stock-based compensation...
When companies pay employees with large amounts of stock and stock options rather than cash, they are required to book the value of the stock/options as a compensation expense as if it were cash.
This reduces reported earnings (and taxes paid on those earnings). But it allows cash flow to soar.
Of course, that raises the question of why every company doesn't simply pay its employees as much as possible in stock/options (they of course need some cash to pay their bills).
In part, the game only works if a company has a steadily rising share price. Employees must be willing to accept stock/options rather than cold, hard cash.
But there's also a major cost: massive dilution. And investors don't like this. Just look at how much Salesforce's share count has increased over the years:
From 2005 to 2022, the number of diluted shares outstanding more than doubled. However, you can see that the share count has been going down since then.
To see what's going on, let's turn back to the cash-flow statement and look at capital allocation:
Here, we can see two totally different stories...
From 2005 to 2021, Salesforce returned basically nothing to shareholders in share repurchases and dividends. Instead, it used its growing cash flow to build cash and make acquisitions. (The largest of which were MuleSoft in 2018 and Slack in 2021.)
But in 2022, Salesforce started buying back stock. That halted the dilution from the growing share count.
And in 2024, Salesforce started paying a small dividend. (The stock currently yields about 0.7%.)
So what happened to cause such big changes?
No fewer than five of the biggest, most aggressive activist hedge funds – Starboard Value, Elliott Management, ValueAct Capital, Third Point, and Inclusive Capital – took significant stakes in the company starting in late 2022 and early 2023. They pushed for changes in areas like expense management, governance, and profitability.
As we can see in the financials, Salesforce responded to the activists. That led to an explosion in reported profits and substantial return of capital to shareholders in the form of dividends and share repurchases.
And the stock responded (aided by a recovery in the market, especially large-cap tech stocks)...
It nearly tripled from its late-2022 low through 2024, as you can see in this five-year stock chart:
However, as noted earlier, the stock is down 33% since its all-time intraday high. Could this be a buying opportunity?
At Friday's close of $247.09 per share, the company has a market cap of about $235.2 billion. With about $3.6 billion of net cash, this puts the enterprise value at around $231.6 billion.
Meanwhile, analysts expect the company to earn $11.35 per share for its current full year and $12.70 per share for the next year. So that means the stock is trading at about 21.8 times current-year estimates and 19.5 times next year's.
Those multiples are slightly below that of the S&P 500 Index for a business that is far above average. So I'm definitely interested in the stock after this pullback.
But this isn't a company or sector I've been following closely over the years – the valuations have always been too high.
So for more perspective, if any of my readers have insights into why Salesforce has sold off and whether it's warranted, I would love to hear from you. As always, you can send me an e-mail by clicking here.
2) Next up is a quick, shameless victory dance...
Less than three weeks ago, on September 4 and September 5, I analyzed office-supply retailer and distributor ODP (ODP) – formerly known as Office Depot. I concluded on September 5:
... any good news could send ODP's stock soaring.
To be clear, it's generally not a good idea to invest in melting-ice-cube businesses in the hopes of making a quick profit on an acquisition. But ODP could be a rare exception to that rule...
I think it's almost certain that ODP is shopping itself... there's no question that it's a no-brainer for [private equity firm Sycamore Partners] to try to acquire ODP to merge it with Staples... and I think ODP's positive free cash flow and decent balance sheet protects the downside.
Sure enough, the stock surged more than 30% this morning on news that another private-equity firm called Atlas plans to take the company private.
3) On a final note, I marked a milestone when I visited friends and family in San Francisco over the weekend...
Here's a picture of me with my cousin and her husband. We had spectacular weather in one of my favorite cities:
While there, I took my first ride in a Waymo driverless car. (These are everywhere in the city.)
Here's a video of it. It was so cool – I felt like I was experiencing the future! And it reminded me of when I got my first cellphone.
Heck, within the next decade, my grandchildren could be asking, "Grandpa, can you explain why cars used to have steering wheels?"
Best regards,
Whitney