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A juggernaut of the market’s growth hit wall, buy these stocks
June 2, 2024
8 minutes read
We danced around it all week. We called out the many culprits for Salesforce’s weak quarterly results on Wednesday — and subsequent stock plunge — including an elongated sales cycle, a measured economic environment, and the need for more senior executives to check off on products. But one we didn’t call out was the law of large numbers, which says that as a company gets bigger, it becomes increasingly difficult to sustain its previous growth rates. How much do we pay for an enterprise software business that may have hit the wall, suddenly slowing down to sales growth in the high single digits from growth in the double digits? What’s the price-to-earnings multiple for a stock in a market that values sales more than cash flow, dividend and earnings per share — especially when that EPS is boosted by stock-based compensation? It hardly matters that Salesforce shares aren’t diluted by that stock-based pay because its buyback program keeps the total outstanding shares flat. So how much would you pay for Salesforce’s revenue growth? Less than you paid before last week’s earnings report . About as much as you would pay for Oracle , which has similar sales growth. CEO Marc Benioff wants investors to focus on the company’s cash flow, which increased 39% in the quarter vs. a year ago, but that’s not what the market is focused on. I have known Salesforce for some time and to say it doesn’t miss is nonsense. That false narrative must be presented by ChatGPT because those of us in the Salesforce trenches have seen periodic slowdowns. But we haven’t seen this kind of slowdown. A slowdown that means we can’t pay what we used to for this great company that helps its clients better communicate and share data with colleagues internally and externally with their customers. I don’t mean to pick on Salesforce, the Dow Jones giant is still very profitable. Any company that can capture $13 billion in sales is a colossus. But Salesforce is the most glaring of the enterprise software behemoths, which include ServiceNow , Adobe , Workday , SAP , Intuit , and fallen star MongoDB . You may bridle at that hand-chosen amalgam, but it’s what investors consider when they value stocks in this space. And this group’s collapse is stunning and has real implications that we had avoided for ages. First, when you see a slowdown and it is persistent as Benioff alluded to in my interview on Mad Money last week, you can no longer asterisk it. Salesforce has become cyclical, not secular, in growth. If the economy slows, Salesforce slows. And it slows more than the hardware companies that aid what the sagacious Jayshree Ullal, CEO of Arista Networks, calls the titans: Meta , Alphabet , Amazon and Microsoft . (Others, in a more prosaic way, call them the hyperscalers). Those companies are spending hundreds of billions on hardware, not software, and the firehose coming out of the data center can’t be easily parsed by any enterprise software company, including Salesforce. One thing we do know, however, is that Salesforce now looks a lot like Oracle. That means it looks like a valuation of 20 times future EPS — about the share price on Friday. Can you pay more? Not with 75% of the analysts calling it a buy. Not with interest rates this high. And not once you realize clients are going to buy less of this software than before. After all, as much as the data center costs, Nvidia CEO Jensen Huang, the data center king, will tell you it’s deflationary and that extends throughout the food chain. Or to put it another way, Salesforce needs its clients to hire more people to increase sales growth. But accelerated computing and generative A.I. means fewer, not more, employees. Couple that with an economic slowdown and you have a nightmare of re-rating. A group of companies that led the market is suddenly an anchor. Which brings me to a second conclusion — that most growth managers are now stumped. They are all steeped in two things: Enterprise software has produced the biggest winners in the investment banking universe, including Salesforce and Microsoft and represents the most important percentage of the companies eager to IPO. That means the juggernaut that’s been at the heart of the stock market’s growth is slowing and the whole IPO-to-high-growth amalgam is grinding to a halt. That doesn’t mean companies like Reddit and Arm Holdings aren’t ready to pick up the slack. They sure are. But they are just reminders that the DevSecOps — development, security and operations — gravy train has been diminished in value. The companies that analyze and interpret your data may be a group that is too crowded with too many superfluous companies, so many that even private equity firm Thoma Bravo, the most enterprise software acquisition machine of all times, can’t buy them all. If you wanted to excel coming out of school, you first had to take computer science, catch on at one of the myriad venture capitalists, and then go to the head of the enterprise software class. Now you have to take computer engineering and angle for a job at a place like Cadence Design , the software company that works to make the Nvidia’s new AI chips a reality right out of Taiwan Semiconductor . The skillset that is needed to develop application software technology is subsumed by one that’s needed to mathematically put 200 billion transistors on a chip before it gets to TSM. They are different tasks, to say the least. If you were to go to a venture capitalist firm now, you might see dozens of these application software companies ready to go into the chute. You might also see a syndicate pushback that amounts to a brick wall, the likes of which you see at an Indy 500. You can storm the gates if you have enough AI — think Elon Musk’s start-up xAI — but not if you have a software as a service (SaaS) for anything except, perhaps, cybersecurity. Now before I go too far here, before I consign this group to a P/E multiple of 20, let’s talk about what it really does and is doing: It’s forcing us to go elsewhere. SaaS is another form of enterprise software, is another form of applications software, is another form of kryptonite. I’d rather be in Norfolk Southern or Expedia — anything but what the VCs stand for. In a market with a finite amount of money devoted to it — you can only produce so much 401k money a year and almost none goes to individual stocks — the glaring nature of buying stock in a company with a static-to-expanding share count isn’t all that valuable. Who knows how much less Salesforce would be worth if it didn’t have that buyback? But what is valuable? How about a company like Wells Fargo that bought back $5 billion in stock already this quarter and sells at 12 times next year’s earnings. It’s also a company that is growing and is a true beneficiary of AI because of all the duplication and by rote documenting that currently exists in a bank. How about a company run by Charlie Scharf, long considered the chief technologist of the banking group? How about a stock of a cohort left for dead that is suddenly a lot more exciting than an enterprise software company because Nvidia eliminates redundancies not for the likes of Workday or SAP but for Wells Fargo and its colleagues? Of course, there will be enterprise software companies that defy the slowdown. Witness ServiceNow. But that doesn’t mean the P/E will expand. It will likely contract because nothing bucks a sector slag. It just makes a company like Wells worth more. I pick a bank because one thing we do know about AI is that it’s causing the most disruption in the staid banking world, not investment banking. That means good news for Goldman Sachs but maybe better news for the workaday Wells. No matter, the sector lift will benefit all in the group. Which is another way of saying this market is, right now, not in the grips of some big cap versus little cap battle, or speculative versus staid. It is a market that is devouring what it used to love and spitting it out as if it is at a wine tasting (not a wine drinking) fest. You want managers drunk on software, not sober and questioning. I know that we all want to figure out the Federal Reserve’s next interest rate move. It’s something that the media — not the true money managers — is focused on. Nothing easier to cover than a bunch of regional Babbitts talking rates. We seem to care about how Treasury auctions go because there isn’t enough money to buy government paper without selling something first. But I am saying those are all abstractions to the top of the card, which is the transfer of capital away from the once fast growing complex of corporate software to anything else. And that’s happening so fast it makes your head spin. Why don’t the auctions grind down all of the market? Because the buybacks are all-too-great and the possibility of mergers too prevalent. It all adds up to a transference that can best be analogized by why we last week added global manufacturing company Dover to the trust. It’s the antithesis of the still-owned Salesforce. Dover has exposure to some of our favorite mega-themes, including the data center, which is obviously one of the hottest areas of industrial activity. Dover is also a Dividend Aristocrat, with 68 consecutive years of dividend growth. Why still own Salesforce? Because it is a living and breathing organism with enough cash to reignite growth through acquisition. It is an acquisitive machine that knew not to buy Informatica . But the fact that it even thought about it reminds me of a flailing Dan Schulman at Paypal going after Pinterest as a sign of desperation. it could have worked, but only if they were smart enough to put Pinterest CEO Bill Ready into the supreme job of the potential amalgamation. We have to see what Salesforce does during its time in the penalty box, unless it’s a permanent box that can’t figure out a new way to break out of until the Fed starts cutting rates. But who in heck would have ever thought that this one’s become a true rate-cut beneficiary? Oh, and if I want that cut, do you mind if we buy more Stanley Black & Decker ? I like that. I will end with it because CRM versus SWK is about an apt comparison as you can find on the eve of a rate cut. Sure, we most likely won’t have a weak unemployment number this week, and that could control the dichotomy. But to me, it just makes SWK even more exciting because it’s going to go up faster than Salesforce when the inevitable rate cut occurs. Right now every manager who owns Salesforce has her Stanley Black & Decker ready, and the move is now upon us. (See here for a full list of the stocks in Jim Cramer’s Charitable Trust.) As a subscriber to the CNBC Investing Club with Jim Cramer, you will receive a trade alert before Jim makes a trade. Jim waits 45 minutes after sending a trade alert before buying or selling a stock in his charitable trust’s portfolio. If Jim has talked about a stock on CNBC TV, he waits 72 hours after issuing the trade alert before executing the trade. 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Marlena Sloss | Bloomberg | Getty Images
We danced around it all week. We called out the many culprits for Salesforce’s weak quarterly results on Wednesday — and subsequent stock plunge — including an elongated sales cycle, a measured economic environment, and the need for more senior executives to check off on products.
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June 2, 2024
8 minutes read
