If you have read my daily musings over the past week, you will know that I place some emphasis on forward P/E. That measure of value is not perfect as it relies on analysts’ predictions of future profits, but is generally more useful than historical data for that very reason. We all know that “past performance does not guarantee future returns” don’t we? Like anything, though forward P/E must be looked at in context; just the number isn’t enough. That is why, when I look at two high profile stocks with triple digit forward P/Es, I can regard both as a buy at current levels.
Both Salesforce.com (CRM) and Amazon (AMZN) trade at sky-high multiples of projected earnings. CRM has a P/E of 175.88 while AMZN’s current share price values the company at 199.75 times estimates for the next twelve months. At these levels, the difference between those two numbers is almost irrelevant; they are both enormous. That doesn’t, however, mean that they are both excessive.
In each case the company has made no secret of the fact that they are not, at this stage, pursuing profitability but are seeking growth. The important thing here, though, is that for both companies, this is a choice. They have both shown that they can make a profit and have done so in the past, but, both see such enormous potential in their fields that they are using rapidly growing revenues to invest in their future.
There is no doubt that growth in both e-commerce and customer relationship management continues at a phenomenal pace, but it is also clear that both industries still have an enormous way to go. According to the Census Bureau, U.S. online sales increased by 4.9 percent in the second quarter of this year over the first quarter, but still only constitute 6.4 percent of total sales, while increasing telecommuting as well as the obvious advantages of centralized records will continue to drive sales for CRM.
Of course, sales growth does not necessarily equate to increasing profits. If the product costs more to produce than it sells for, then more sales just mean more losses, but neither Salesforce nor Amazon has that problem, producing $1.09 billion and $3.3 billion of levered free cash flow respectively. They are just choosing to re-invest that cash. That is something which, unfortunately for the economy in general, seems to be out of vogue at the moment. Returning value to shareholders through dividends and stock buybacks gives a quick return to those shareholders, but hints at a lack of imagination and entrepreneurial spirit, and a glass half empty view of the future. Neither Amazon nor Salesforce can be accused of those things.
In general, I am wary of companies where multiples of sales rather than good old-fashioned profits become the metric du jour. Losing money, like losing of any kind, can easily become a habit. However, when industries are expanding as rapidly as online retail and customer relationship management, the company that emerges dominant in the field will have such enormous profit potential that chasing growth above all else makes perfect sense. Both Amazon and Salesforce, it could be argued, have already achieved dominance. The newer nature of cloud based data management means that Salesforce will still have competitors to fight off but so far even the biggest players in tech have struggled to compete effectively in the space. Hands up anybody who can name Microsoft’s product in the same field…
Assessing companies is always a question of balancing conflicting evidence and views, but never more so than when profitability is being sacrificed for growth. The first thing to ask oneself in that situation is “is it a deliberate choice?” If it is and there is reason to believe that the company concerned can turn on the profit tap at some point then the next question is “are the growth expectations reasonable?”
When looked at in that way it becomes obvious that, when assessing CRM and AMZN, P/E ratios are irrelevant. Their current level of profitability doesn’t truly reflect their ability to make money. They are both simply choosing to invest in growth, for which, as participants in the global economy, we should all be thankful and, as long as they continue to do so, the stocks still remain attractive.