Trading Success
In this edition of the Smart Investor newsletter, we examine a global market leader in business software. But first, let’s delve into the latest Portfolio news and updates.
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Portfolio Updates
❖❖❖ An important update about Super Micro Computer (SMCI): shares fell about 28% over the past month, weighing on the performance of the overall Portfolio. Amid the turbulence in AI-related and chip stocks in general, a slight weakness in SMCI’s earnings report was enough to spook the markets. After that, sentiment was further hit by a report from a notorious short-seller Hindenburg, which alleged “accounting manipulation.”
The allegations by themselves might not have been enough to cause more than a momentary dip for a couple of weeks, as short-seller attacks on high-profile stocks abound. Indeed, analysts mostly brushed off the allegations regarding Supermicro. JPMorgan analysts saw no substantial evidence of accounting offenses in Hindenburg’s report. Meanwhile, Rosenblatt analysts said they are “old news or inaccurate.”
However, SMCI saw its shares plunge after the company unexpectedly postponed the release of its annual filing with the SEC, saying that it needed to assess “the effectiveness of its internal controls over financial reporting.” The lack of clear communication with the investors at the time of the delayed announcement exacerbated investor nervousness.
Later, Supermicro confirmed that there would be no changes to its previously announced financial results for F4Q24, FY24, or its forward guidance. Despite these reassurances, many analysts have cited heightened uncertainty, cutting their price targets and ratings. On the other hand, some argue that while late 10-K filing is problematic, the selloff is overdone.
Yesterday, the company’s CEO Charles Liang issued a letter to investors and customers, which was also filed with the SEC, addressing the short-seller’s report and filing delay. In the letter, he denied Hindenburg’s accusations as “false or inaccurate,” adding that the company would address those statements “in due course.” Liang added that neither the accusations nor the filing delay will affect its production capabilities and operations, reaffirming Supermicro’s commitment to its customers.
Hindenburg’s report and filing delay certainly came as a surprise, both to us and the markets. Although for now, there has been no change in our view of the stock’s stellar long-term potential, the elevated uncertainty may continue weighing on the stock until its next earnings report at the end of October. Since the damage has already been done (and since most other Portfolio stocks have continued to perform well, counterbalancing the hit), we are for now taking a “wait and see” approach towards SMCI, ready to hit the “Sell” button at a first hint of further negative news. However, we understand that some investors may find it easier to let go of the stock in these circumstances, locking in the ~72% gain made since we added SMCI to the Smart Investor Portfolio.
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❖ PayPal (PYPL) was Smart Portfolio’s best performer in August, clocking in a gain of almost 17% (versus the S&P 500’s 5.7%). The stock has been on a strong run following PayPal’s latest report, featuring earnings and revenue that topped estimates and raised EPS guidance.
❖ Berkshire Hathaway (BRK.B) was the best performer in the S&P Financials sector last week, reaching an all-time high. Warren Buffet’s financial conglomerate became the first non-technological company ever to reach a market capitalization of $1 trillion.
❖ Dell (DELL) saw its stock surge after releasing blockbuster second-quarter results, with revenue growth led by record income from its server and networking segment. The results signaled Dell’s ability to capitalize on surging corporate AI-infrastructure spending, leading to multiple analyst upgrades for the stock.
❖ Lam Research (LRCX) reported a strong set of results for its FQ4 2024 and the full fiscal year, surpassing analyst EPS estimates on both accounts. In addition, the chipmaking equipment producer raised its current-quarter revenue guidance above analyst projections, citing an AI-driven surge in spending on semiconductor equipment. Following robust performance and a strengthening outlook, the company announced a 15% dividend hike, beginning with the payout on October 1st. However, the stock suffered a sell-off in the past few days, taken down by a tumble in the shares of Nvidia, which pressed on the whole semiconductor sector.
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Portfolio Earnings and Dividend Calendar
❖ The Q2 2024 earnings season is drawing to an end, but companies whose fiscal year is shaped differently continue to report their results. Thus, Broadcom (AVGO) will report its FQ3 2024 earnings on September 5th, and Oracle (ORCL) is scheduled to release its FQ1 2025 results on September 9th.
❖ The ex-dividend date for Alphabet (GOOGL) is September 9th.
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New Buy: Salesforce, Inc. (CRM)
Salesforce is an American cloud-based software company headquartered in San Francisco, California. It provides customer relationship management (CRM) software and applications focused on sales, customer service, marketing automation, e-commerce, analytics, and application development.
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Meteoric Rise to Fame
The company was founded in 1999 by former Oracle executive Marc Benioff, who continues to serve as its CEO, and has quickly grown into the world’s leading customer relationship management software provider.
Today, with a market cap of $242 billion, CRM is the world’s 47th most valuable company. It is the world’s seventh-largest software company by both revenue and market cap. Its annual 2023 revenues of $34.9 billion have placed it at the #123 spot on the Fortune 500 list. CRM shares began trading on the NYSE in 2004; since 2020, Salesforce has also been a component of the blue-chip DJIA index.
Over the years since its founding, Salesforce has shown significant growth in both market capitalization and income. Over the past decade, the company’s market value has grown almost 7x, while annual revenues increased nearly 9x. 2024 is Salesforce’s 11th consecutive year as the top global CRM provider.
Salesforce’s rapid growth is attributed to both internal innovation and growth efforts and acquisitions. Over its history, the company made over 60 buyouts, which helped strengthen its market position and expanded its offerings. The most notable acquisitions in recent years were Slack, Tableau, and MuleSoft. The integration of these products into Salesforce’s portfolio has expanded the company’s abilities far beyond its initial customer-management software offering. CRM now houses a broad corporate software ecosystem, ranging from sales management to productivity tools to financial services and analytics.
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Leading Tool Suite, Sticky Customer Base
Salesforce provides CRM platform and tools to over 150,000 customers worldwide, including leading global corporations like Amazon, Spotify, Coca-Cola, McKinsey & Company, Walmart, T-Mobile, Bank of America Corporation, BMW, American Express, UnitedHealth Group, and other industry leaders. Over 90% of the Fortune 500 companies use Salesforce’s software.
While CRM sells its products and services globally, its largest geographic market is the U.S., which is responsible for about 67% of revenue. An additional 23% of revenues are sourced from the U.K. and Europe, and the rest come from Asia and the Pacific.
Its surging popularity stems from high-quality services and products, as well as Salesforce’s ability to offer ready-made solutions specifically tailored to the needs of different industries and company sizes. CRM’s customer base is very sticky, as the company’s clients have reported fast payback and very high ROI from its software.
According to a Forrester Consulting study, CRM’s Marketing Cloud product has on average delivered 300% ROI over three years. In addition, according to client surveys, Salesforce’s products have helped them boost productivity by 40% on average and increased conversion rates by 45%. As a result, corporations tend to stay with CRM for a long time, while over 60% of their existing customers report a tendency to purchase additional subscriptions and services.
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CRM Owns the CRM Market
In the past five years, CRM’s revenues grew at a CAGR of 20%, while its earnings-per-share rose at a compound rate of 37%, the fastest growth rate among comparable peers. Fast growth has supported Salesforce’s increasing market share, which has reached almost a quarter of the global customer-management software market, outpacing the combined market shares of its competitors (Microsoft, Oracle, SAP, and Adobe).
Its Marketing Cloud segment holds a 15% market share, even winning customers from long-standing industry champions such as HubSpot. Salesforce owns ~40% of the Sales Cloud market worldwide, three times that of the second-place holder, Microsoft. In the Service Cloud market, CRM commands about 50% market share, while its largest competitor in this space, Oracle, holds ~8.5%.
The fast ascent of the company to the top echelon has been powered by its winning subscription-based business model, which is based on highly consistent and visible revenue flows. Salesforce’s revenues stem from two segments: Subscription and Support, responsible for over 93% of the total, and Professional Services.
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Stellar Financials and Innovation-Led Growth
Despite numerous acquisitions and heavy investment in R&D, Salesforce continues to display perfect financial health. The company has more cash than its total debt, earning more interest than it pays. In addition, its capital efficiency and productivity metrics are very strong. CRM’s ROE, ROA, and ROIC far surpass the average for its peers in the industry. Its gross, operating, and net income margins are in the top 25% of the generally high-margin Software industry. Besides, Salesforce is a cash-churning machine, as reflected in its top 5% FCF margin.
Although it is an undisputable market leader, Salesforce continues to innovate and expand its technological excellence. The company was among the first to embrace artificial intelligence technology with the launch of its Einstein platform in 2016 and has been aggressively investing in AI over the years. Its AI advancement is expected to further cement its leadership status, fending off competition.
In 2023, the company launched its new Einstein 1 Platform – an integrated, intelligent, and automated open platform that is integrated across all of Salesforce’s main products. It also houses Data Cloud, a hyper-scale data engine that connects all customer data. Moreover, Einstein also has Generative AI capabilities such as Einstein Copilot, its conversational AI assistant for CRM that can access data from Salesforce’s Data Cloud, providing support for all the company’s applications.
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AI Monetization Key to Profitability
Einstein 1 immediately attracted praise from clients, and the platform has been key to the company’s recent outperformance. Thus, on August 28th, CRM reported a strong set of results, beating analyst revenue and earnings expectations and surpassing its own guidance. The company said that much of the success came on the back of new bookings for its AI products, which more than doubled in the quarter. Thus, CRM may now serve as the Software industry’s case study on successful conversion of AI investments into revenue increases.
The company reported an 8% increase in sales from a year ago, with current remaining-performance obligations (a key metric for SaaS companies) rising by 10%. Since it is a mature company not expected to produce explosive revenue growth, the focus has strongly shifted to the aspects of profitability. That’s why the sixth straight quarter of expanding operating margins was the main source of excitement. Salesforce reported a 21% year-on-year increase in earnings-per-share, its seventh consecutive quarter of triple- or high double-digit EPS growth. The company generated $755M in FCF over the quarter, a YoY increase of 20%.
Looking ahead, Salesforce maintained its conservative revenue guidance for the full fiscal year, envisioning overall growth of 8% to 9% and subscription and support revenue growth of around 10%. However, the company did increase its adjusted EPS guidance, raising its annual growth forecast from ~20.5% to ~22.5%.
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Total Return in Focus
Following strong FQ2 results and guidance updates, analysts from leading Wall Street firms upgraded their outlook for the stock and lifted price targets, now forecasting an upside of ~22.4% in the next 12 months. The company continues to expand its AI capabilities, planning to introduce a new autonomous AI agent for business customers as soon as this month, which is expected to boost the stock even further.
CRM shares have returned only 14% in the past year, as they sustained a significant decline in May after the previous quarter’s report contained weaker-than-expected guidance. However, coupled with a strong past and expected earnings growth, this has created a valuable entry opportunity, as the company trades at very attractive valuations, with trailing and forward PEs at about 40% below its five-year historical trend. Salesforce also comes at the bottom of the valuation scale for comparable Software peers. In addition, it appears about 40% undervalued based on future cash flow projections.
Notably, Salesforce initiated dividend payments this year and has already made two payouts to shareholders. While its dividend yield is a low 0.3%, it is expected to gradually increase over the next several years.
In addition, in February this year, Salesforce increased its share buyback plan by $10 billion. The number is very significant given that in all the years of the company’s existence up to that date, it has repurchased a total of $11.7 billion. In H1 FY25, the company performed buybacks totaling $6.5 billion.
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Investing Takeaway
Salesforce is an undisputed customer-management software leader, holding significant market shares in all its operating segments. The company is well-positioned to capitalize on its strong market standing, sticky and loyal customer base, and leverage AI investments for revenue acceleration. Thanks to its consistent efforts at expanding profitability, CRM looks set to continue growing earnings at a pace that can be considered very fast for a mature software giant. Taking into account the company’s alignment with shareholder interests, transpiring from dividend initiation and large buybacks, its current stock price appears to be a great value proposition. This, coupled with its growth prospects, makes for an attractive long-term investment.
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New Sell 1: Applied Industrial Technologies (AIT)
Applied Industrial Technologies, Inc. is one of North America’s largest distributors and service providers of industrial motion and control technologies. It supports the Maintenance Repair Operations (MRO) and Original Equipment Manufacturing (OEM) operations of businesses in virtually every industry segment, as well as government entities, mostly in the U.S. and Canada.
While the industrial mid-cap company displays stellar financial health, its growth has been less so. AIT’s revenue growth has stalled, with quarterly top lines virtually unchanged since fiscal Q4 2022. While EPS has continued to rise, its growth has fallen to single or low-double digits in the last three quarters, including the results of FQ4 2024, reported on August 15th.
Notably, the company lowered its fiscal 2025 guidance, projecting flat revenues and softer earnings at the mid-point than previously communicated. Although AIT’s peers have seen similar macro headwinds that are expected to continue into the next year, the company’s valuations are outstretched vis-à-vis its growth outlook, limiting further potential upside. Taking all that into account, we find it prudent to lock in our gains of ~20% and sell the stock.
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New Sell 2: Merck & Company (MRK)
Merck & Co., Inc. is an American multinational healthcare company that delivers health solutions through prescription medicines, biologic therapies, vaccines, and animal health products. Merck is the second-largest pharmaceutical company in the U.S. and the third-largest in the world.
Although MRK’s drug and vaccine portfolio is well-diversified, its revenues are highly dependent on one specific product: Keytruda, the world’s top-selling drug, which accounts for 42% of MRK’s total annual sales. The patent on Keytruda ends in 2028, marking the largest expiration in pharma history.
The company has been working hard to fill the potential revenue gap, and its current pipeline includes several cancer, cardiometabolic, and immunology drugs which have the potential to more than cover the prospective hit from the Keytruda patent expiration. In addition, the pharma giant is working on an improved version of Keytruda, which, if successful, would extend the medicine’s financial value well beyond the original’s patent expiry date.
However, analysts have increasingly voiced concerns over Merck’s prospects, as it faces several major challenges. Some of them are related to regulatory scrutiny, such as the impending FDA decision on whether to restrict the use of Keytruda for certain types of cancer due to adverse side effects. In addition, one of MRK’s flagship treatments – its diabetes drug Januvia – will now be generating significantly less revenue due to Medicare price renegotiation. Another threat is arising from China, where sales of Merck’s HPV vaccine Gardasil fell in the latest reported quarter. Since China accounts for about half of the total Gardasil sales, the company’s assessment of a potential downtrend may translate into a major revenue reduction going forward.
Merck remains a well-run company that develops strategies to mitigate, if not overcome, numerous challenges. It has multiple positive catalysts under its belt, which include the potential approval of Keytruda for additional indications, as well as several drugs that hold significant revenue growth potential, and new treatments in its extensive pipeline.
However, with investor sentiment already fragile, near-term challenges may outweigh robust long-term prospects. We therefore believe selling MRK to be a prudent step, but plan to revisit this pharma powerhouse in the future.
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Portfolio Stocks Under Review
❖ Vertex (VRTX) remains under review following its underwhelming Q2 results, which included an EPS miss. The company reported a wider earnings-per-share loss than was expected. Notably, the negative EPS is a one-time event brought on by expenses associated with an acquisition of Alpine Immune Sciences, as well as increased investments to support launches of new therapies. The biopharma giant raised its full-year product revenue guidance, citing growth in sales of its cystic fibrosis (CF) treatment and the soon-to-launch gene therapy Casgevy. The stock fell from its all-time high following Q2 underperformance, though not by a large percentage. Still, VRTX’s performance since the report has been choppy, as investors and analysts are still undecided regarding its prospects. Some analysts have cut their outlook on the stock, citing limited near-term upside opportunity given its high valuation. On the other hand, Vertex’s stellar finances and cash-producing capabilities, along with its strong portfolio of existing and prospective treatments, provide a strong argument in favor of the company.
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Smart Investor’s Winners Club
The 30% Winners Club includes stocks from the Smart Investor Portfolio that have risen at least 30% since their purchase dates.
Despite the market volatility and the hit suffered by semiconductor stocks, our list of Winners still holds 16 stocks: GE, AVGO, ANET, SMCI, EME, ORCL, TSM, CHKP, GD, PH, HWM, APH, TPL, VRTX, AMAT, and ITT.
The next in line to enter the lucrative club is still REGN with a 24.6% gain since its purchase date. Will it close this minute gap, or will someone else outrun it to the finish line?
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Smart Investor Portfolio
| Portfolio YTD Return |
Portfolio Volatility (Beta) | Portfolio Dividend Yield |
| 20.56% | 1.13 | 0.81% |
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Disclaimer
The information contained in this article represents the views and opinions of the writer only, and not the views or opinions of TipRanks or its affiliates and should be considered for informational purposes only. TipRanks makes no warranties about the completeness, accuracy, or reliability of such information. Nothing in this article should be taken as a recommendation or solicitation to purchase or sell securities. Nothing in the article constitutes legal, professional, investment and/or financial advice and/or takes into account the specific needs and/or requirements of an individual, nor does any information in the article constitute a comprehensive or complete statement of the matters or subject discussed therein. TipRanks and its affiliates disclaim all liability or responsibility with respect to the content of the article, and any action taken upon the information in the article is at your own and sole risk. The link to this article does not constitute an endorsement or recommendation by TipRanks or its affiliates. Past performance is not indicative of future results, prices, or performance.
