Three companies in one of the hottest tech sectors just released
earnings. And all three stocks are on the rise this
morning. But the surprising thing is that analysts and investors
continue to be bullish on these stocks despite growing
These companies operate in a sector known as "enterprise
software." Enterprise software stocks including
), Splunk (
are some of the most loved
, and enjoy remarkably rich valuations.
The bullish case on these stocks seems to be completely
reliant on rapid revenue growth, which investors assume will
translate into future profits.
But skeptics point to one big issue: these profits aren't
While each of these companies continues to see their stock
soar to new highs, losses continue to grow at an astonishingly
3 of the Most Expensive Stocks Today
Let's examine the three biggest stocks in the sector:
Salesforce, Splunk, and Workday. These players undoubtedly get
the bulk of the attention from the media and investors.
Theoretically a lot of this attention is deserved. The
disruptive potential of these cloud-based enterprise software
players is huge, and the revenue growth is real. Demand for these
services is there. But thus far, these companies aren't turning a
A lot of stockholders will point to the unique nature of the
Subscription as a Service (SaaS) business model, as a reason for
the discrepancy in valuation. With enterprise software contracts
typically spanning one to three years, revenue is recognized
linearly on a quarterly basis. This gives the appearance of
steady sustained growth over the long term.
As these businesses have matured, it's surprises me to see
growing losses. And what's surprised me even more is that no on
seems to care at all.
Let's take a quick look at each companies revenue and
FY14 Operating Profit Growth
The following table shows just how expensive these stocks are
on a price-to-sales (P/S) and price-to-earnings (P/E) basis.
FY14 GAAP P/S
FY14 GAAP P/E
Despite rapidly growing top-lines, every company managed to
increase its losses by a significant amount year over year. This
seems particularly worrisome given that all these companies are
enjoying ludicrous P/S valuations.
Many tech companies - including these three - like to report
earnings on a non-GAAP basis. This allows them to selectively
remove pesky expenses including stock options, write-offs, and
taxes. On a non-GAAP basis, the income statements look far
more favorable. Yet these numbers doesn't provide a true view of
As we saw this week, yet another quarter of growing losses was
reported from each of these three companies. And you guessed it
right! All three stocks are trading within 5% of their all-time
Sooner or later investors are going to have to start demanding
profits, or some sort of tangible value. Very rarely has there
been a growth company that was unprofitable during its
years and subsequently enjoyed long-term success.
Apple, Google, IBM, Microsoft, and Oracle are all great
examples of tech companies that were profitable during the period
where they experienced the most rapid growth. No - it doesn't
seem as though these enterprise software stocks are "the next
So why are investors giving a free pass to the most expensive
stocks like Salesforce, Splunk and Workday?
The simple answer is due to their "software as a Service" or
SaaS business model. But this is nothing more than an argument of
"this time it's different because…." And anybody
in shares of these companies now better hope that's right. With
stratospheric valuations and no assets to fall back on, these
stocks will have a long way to tumble when the growth finally
If you own shares of these high flying enterprise software
stocks, now may be a good time to be locking in your gains. If
profits never materialize, there is no question these stocks will
be trading at significantly lower prices sometime soon.
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