Salesforce (CRM 1.68%) fell out of favor with investors this year, but this is now creating a compelling opportunity for new buyers. The company is navigating a major strategic shift as it enters a new phase of its corporate lifecycle. As investors process that shift, the stock's valuation ratios are now too cheap to ignore.
1. Growth is still a bright spot
Salesforce was a high-growth rockstar for years, but it's settling into a more mature phase. The company's revenue growth rate is slowing as it moves closer to market saturation. That's a natural part of the corporate maturation process, and businesses generally slowly shift their focus from expansion to profitability as they achieve scale. That can be a complicated process in the stock market as growth investors give way to value-oriented investors who have different goals and risk tolerance.
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Salesforce is in the midst of that shift, but it's important to keep things in perspective. The company is still growing faster than the economy in general and many companies in the stock market. That's especially true relative to other large-cap stocks. The company's sales increased 11% in its most recent quarter, the same rate reported one year earlier. Its forecast and consensus analyst estimates call for growth in the range of 7% to 9% for the full year.
CRM Revenue Growth Estimate for Current Fiscal Year data by YCharts
Salesforce isn't the stock for you if you're looking for a dynamic disruptor with enormous growth potential. That said, it's still expanding rapidly enough to deliver impressive shareholder returns. Don't confuse a slowing growth rate for a low growth rate.
2. Salesforce transformed into a cash-flow powerhouse
Improved profitability becomes essential as growth slows, and Salesforce is delivering on that goal. The company has exercised impressive cost-controlling measures, and those have translated to rapid improvements in profits and cash flow as sales increase.
Salesforce's operating margin was 19% last quarter, up from 5% in the prior year's corresponding period. The company's adjusted margin was 32%, after excluding certain one-time and non-cash expenses. Improving margins on higher sales means that profits are outpacing the top line.
CRM Net Income (TTM) data by YCharts
Free cash flow might be the most important fundamental metric for business valuation. Financially healthy corporations can either distribute cash flows to shareholders, or they can deploy that cash for growth through hiring, product development, or acquisitions.
Salesforce reported more than $6 billion in free cash flow last quarter, over 60% of quarterly revenue. Much of that came from changes to working capital, such as collections on outstanding invoices, but it's reasonable to expect free cash flow to approach 40% of revenue moving forward.
The company's operating cash flow has compounded at a 26% annual rate over the past three years. Investors who are skeptical about its top-line growth rate should keep the impressive bottom-line performance in mind.
CRM Cash from Operations (TTM) data by YCharts
3. The stock's valuation is attractive
Many growth investors have moved on to greener pastures as Salesforce's rate of expansion has cooled. The market has also responded unfavorably to several things, including the company's outlook for this year and recent news on potential acquisitions. These factors combined to dismantle the stock's momentum -- it's down significantly from its pandemic-era and year-to-date highs.
That's not a bad thing for potential investors. On the contrary, Salesforce stock now has a forward P/E ratio of 23 and price-to-free-cash-flow ratio of 20. Those are low compared to many of its large-cap enterprise software peers. The 26% cash-flow CAGR also suggests that Salesforce's PEG ratio is below 1, which is generally the benchmark for an attractive growth-adjusted valuation.
Salesforce has a wide economic moat and a bright outlook for cash-flow growth. Its valuation no longer reflects the high sales growth rate that the company achieved in previous years. The stock has clear financial fundamentals to support its valuation over the next few years. That's shifted the balance away from risk in favor of long-term upside potential.
