Stock Market

A near-perfect storm of negative catalysts caused Salesforce (NYSE:CRM) stock to plunge after reporting its first-quarter results on May 30. The shares are likely to stay weak for some time due to the Street’s current aversion to software names in general and Salesforce in particular.

Nonetheless, the company’s valuation is quite undemanding at this point, its operating cash flow is rapidly increasing, and it should get a significant bump from the artificial intelligence (AI) boom over the longer term. What’s more, the Street is likely to become much less hostile to software stocks in the medium term.

In light of these points, I view CRM stock as a hold for now.

A Near-Perfect Storm

With the Street already looking askance at software companies, Salesforce’s slightly lower-than-expected Q1 results and Q2 guidance caused a huge decline of its shares. Specifically, the firm provided Q2 revenue guidance of $9.2 billion to $9.5 billion, versus analysts’ previous mean outlook of $9.34 billion. Moreover, its Q1 sales came in at $9.13 billion, slightly below the mean outlook of $9.17 billion, while its current remaining performance obligations (CRPO) bookings rose 10%, significantly below the average estimate of 11.9%.

The misses came as the Street has soured on software stocks in general. As I noted in a Jun. 11 column, the iShares Expanded Tech-Software ETF (NYSEMKT:IGV) fell from $85.13 on May 20 to $80.43 on Jun. 7. I blamed the decline on weaker-than-expected quarterly results reported by a small number of software makers, including Salesforce, and large investors’ current focus on the six largest tech names and a few other hardware makers benefiting tremendously from the AI boom.

Still Growing Quickly and Generating Impressive Cash Flows

Objectively, the company’s business is growing relatively rapidly and is quite profitable. In Q1, its revenue jumped 11% versus the same period a year earlier and it maintained its full-year sales growth outlook of 8% to 9%. On the profitability front, the firm’s operating cash flow soared 39% year-over-year in Q1 to a huge $6.25 billion and it continues to expect its operating cash flow to climb 21% to 24% for the full year.

At the midpoint of that range, its operating cash flow would come in at $12.5 billion. That means its shares are changing hands for a relatively low valuation of 18.67 times its expected forward operating cash flow.

A Viable AI Strategy

Meanwhile, the firm has launched a new software product called Data Cloud. By providing its customers with a way to compile their data into a single source, Salesforce is preparing them to be able to easily use the AI capabilities of Salesforce’s Einstein 1 Platform to analyze that data. As a result, I believe that, after many of its customers adopt Data Cloud, Salesforce will be able to convince them to use Einstein 1 to analyze and draw conclusions from the information that they’ve compiled into the application.

And so far, the strategy appears to be working as it convinced over 1,000 enterprises to adopt Data Cloud for the second quarter in a row in Q1, while 25% of its deals that generate $1 million or more included a Data Cloud subscription.

Also importantly, Salesforce on May 21 disclosed that it had agreed to use IBM’s (NYSE:IBM) large language models to enhance the AI capabilities of its Einstein 1 Platform. That should make Einstein 1 much more attractive to enterprises going forward.

A Software rebound and the Bottom Line on Salesforce Stock

Sometimes the Street gets overly negative about certain sectors. For example, for the first several months of 2023 large investors soured tremendously on regional bank stocks. But most of the sector’s names ultimately rebounded tremendously over the next year.

Software stocks should go through a similar trajectory within the next 12 months, ultimately lifting Salesforce stock. However, the shares are likely to be weak for some time before such a rebound occurs. Therefore, I view Salesforce as a classic hold at this time.

On the date of publication, Larry Ramer did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines

Larry Ramer has conducted research and written articles on U.S. stocks for 15 years. He has been employed by The Fly and Israel’s largest business newspaper, Globes. Larry began writing columns for InvestorPlace in 2015. Among his highly successful, contrarian picks have been SMCI, INTC, and MGM. You can reach him on Stocktwits at @larryramer.

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