Don't Turn Your Back on This Beaten-Down Tech Stock

We're not in a recession yet... But turbulence is already rocking the economy.

Companies have been implementing cost-cutting measures amid all the uncertainty. News of mass layoffs and hiring freezes has been dominating the headlines.

The most significant freezes have been in the tech industry. In recent months, Big Tech titans like Facebook owner Meta Platforms (META), Amazon (AMZN), and Google parent Alphabet (GOOGL) have pumped the brakes when it comes to hiring.

And last month, one of the world's largest software companies joined their ranks.

Salesforce (CRM) has a history of laying off employees as a reaction to the broader tech environment. The company cut 1,000 jobs in August 2020 despite performing well during the pandemic. That same quarter, it surpassed $5 billion in revenue for the first time.

Economic uncertainty and the huge tech sell-off are driving this round of cost-cutting. Tech stocks – as measured by the Technology Select Sector SPDR Fund (XLK) – are down 25% this year.

Salesforce has fallen with the rest of the sector. Its stock is down 36% year to date. In addition to laying off an unspecified number of employees, the company froze hiring until at least January 2023.

But that doesn't mean the market is turning its back on Salesforce...

You see, tech has performed poorly because the sector is full of unprofitable companies with loads of debt.

Take ride-hailing app Uber Technologies (UBER). It has generated negative operating profits for every year it has been public. And it's sitting on almost $12 billion in debt. The company has earned its 34% plunge.

Salesforce, on the other hand, is profitable. And it has far less debt than Uber relative to its size.

Like many software companies, Salesforce's profits were inconsistent in its earlier years as it focused on growth. But once it established itself, its returns took off.

The last time Salesforce laid off employees, its Uniform return on assets ("ROA") took a significant hit. That was back in fiscal year 2021.

(Salesforce's fiscal year ends in January. So fiscal year 2021 covered the majority of 2020.) 

Uniform ROA peaked at 36% in fiscal year 2018... before falling to 16% in 2021 due to the pandemic. Still, as we said, Salesforce wasn't in any danger. Even in a bad year, returns were well above its 6% cost of capital. They also outpaced the 12% corporate average.

And in fiscal year 2022, the company was back to operating at its full potential. Take a look...

The latest round of layoffs probably won't spell doom for Salesforce...

To understand what the market expects from the company going forward, we can check out its Embedded Expectations Analysis ("EEA").

Our EEA framework uses Uniform Accounting to show us exactly how investors think a company will perform based on its current stock price. Here's how it looks for Salesforce...

Salesforce is undoubtedly feeling the pressures of an uncertain economy. And as conditions worsen, more layoffs could follow. But that doesn't mean you should avoid the stock today. As you can see, the market thinks Salesforce's Uniform ROA will rise to a near-record 35% by 2027.

It might not be priced as the greatest software company of all time these days. But investors are still expecting a lot from Salesforce. And we think we know why.

Tomorrow, I'll explain the other piece of the puzzle that's boosting investor confidence in this strong company. But in the meantime, don't bet on its stock falling much further.

Regards,

Joel Litman
November 1, 2022