Investors Are Praising Salesforce.com But Now's the Time to Be Careful

By Ben McClure The market cheered Salesforce.com's CRM impressive third-quarter numbers, pushing the stock up another 10% in after-market trading last night. In a slow economy -- in which the company's direct rivals, Microsoft MSFT, IBM IBM, and SAP SAP, aren't doing much to excite investors -- the sight of a stock delivering rapid growth brings back memories of the software market's heydays. Unfortunately, those pleasant memories include stocks that were vastly over-valued. At this morning's pre-market price of $126, Salesforce.com is definitely a member of the club.

(To read Josh Lipton's article on how gold regains its luster, click here.)

Sure, Salesforce.com is certainly delivering superb financial performance. The market leader in cloud-hosted business software grew revenues by 30% to $429, its biggest top-line gain in seven quarters. Meanwhile bottom-line earnings -- excluding special items -- jumped to $0.32 from $0.16 in the third quarter last year. In a sluggish economy -- or even in a good economy for that matter -- those are mighty impressive numbers. The stock is no slouch, either, having rallied 57% this year versus 10% for the Nasdaq market. Trading at $115 and change, the shares are up more than 400% since November 2008, giving the cloud-hosted computing software vendor a market capitalization approaching $17 billion.

(To see Jeff Harding's opinion on what to expect from holiday sales, click here.)

Unfortunately, as great as the stock might be, it's looking dangerously pricey, now trading somewhere around 100 earnings -- leaving absolutely no room for disappointment or error. Wall Street analysts reckon Salesforce.com can deliver earnings per share for this year of about $1.16. But, for argument's sake, imagine that the consensus estimate is a low-ball figure. Instead, let's assume that Salesforce.com will earn at least $1.25 a share this year. If it does, it's priced at a staggering 100 this year's earnings. So as not to rely on Wall Street, let's try a different set of projections. The third-quarter report shows that revenue grew at over 30%, while its operating profit margins are 8%. Let's be optimistic and assume the company can deliver 40% revenue growth for the year. And let's assume it manages to squeeze out more profits this year. Margins should be strong. So, let's say that the company ends the year with operating profit margin of 10%. Based on these estimates, here's how much income Salesforce.com will make this year:

(To see Jim Koford's reasoning on how bears have the opportunity to change market trends, click here.) 2011 revenue (40% growth): $1.83 billion 2011 operating income (10% margin): $183 million 2011 net income (25% tax): $138 million The company currently has about 140 million shares fully diluted. So, this earnings forecast for 2011 would deliver about $0.99 per share. At a price of 126, the stock is trading at 125 times our estimate.

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