Tickers in this Article: CRM, GOOG, ORCL, MSFT, SAP, INTU
For as long as leading software-as-a-service (SaaS) provider Salesforce.com (NYSE:CRM) posts explosive revenue growth and increasing subscriber figures, investors should not expect most sell-side analysts to ask many pointed questions about the actual profitability and real earnings of this business. What experienced investors - those who have been through a bubble or three - do know is that eventually real earnings and valuation always matter. That makes Salesforce.com a tricky name to like at today's price.

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Fiscal First Quarter Earnings - More of the Same
Salesforce.com's fiscal first quarter results really did not break new ground; for a company that has often reported excellent (and above-expectation) growth, this was just another quarter's work well done. Nevertheless, the company did report that revenue rose 34%, with reported subscription revenue up 35%. Moreover, there was good performance across much of the business, including SFA, Chatter and Force.com.

Margins and profitability were more problematic however. Gross profit more or less kept base (on a GAAP basis), as this line grew more than 31%. Operating profit was a different story, though, as the company reported an operating loss due to far higher sales and marketing costs. Even on a non-GAAP basis (that is, excluding the significant impact of stock compensation expense), EPS showed a significant decline.

A Pothole Or the Beginning of the Crevasse?
Companies and analysts have largely conditioned investors to just pay little or no attention to profitability. Instead, concepts like "sub growth" or "value per sub" are bandied about to draw attention away from core profitability. Although that can make a certain amount of sense in the early days of a company, that becomes problematic as the story ages.

One of the arguments in favor of Salesforce.com has been the positive future leverage that is supposed to come from scale - as the company gets bigger, it should get more profitable. When is that going to happen? Clearly it is not happening now. Even allowing the argument that the company is still building its business and that these are early days for cloud computing/SaaS, will Salesforce.com be able to produce the above-average profitability it needs to validate its valuation when it is also has to fend off growing competition from Google (Nasdaq:GOOG), Oracle (Nasdaq:ORCL), Microsoft (Nasdaq:MSFT) and SAP (NYSE:SAP)?

Investors should also be careful not to ignore the impact of shareholder compensation. Companies, especially tech companies, work hard to divert attention away from this line item (since it's not a "cash expense"), but approximately $48 million in expenses (or 10% of revenue) is tough to ignore. Moreover, just because it is not a cash expense does not mean its not real - what good does it do an investor to own a growing company if that stake is being eroded through compensation awards to employees?

The Bottom Line - Too Rich and Too Hot
Salesforce.com has some very good product offerings and I have little doubt that the company will stand shoulder-to-shoulder with Microsoft, Oracle, Intuit (Nasdaq:INTU) and other major players for years to come. The question, though, is whether they can match the profitability of these more seasoned rivals - right now Salesforce.com is spending about half of its revenue on sales and marketing. The question is, then, whether the company can hold on to existing clients and continue to grow the business at a more reasonable level of marketing expenditure.

In the meantime, the valuation on this stock is just nutty. True, tech investors love growth and will pay dearly for it, but it is all too easy to produce a roll-call of once-hot growers that sported eye-popping valuations that were never validated by the eventual financial performance. Salesforce.com may very well continue to do quite well as a company, but at today's prices, it's hard to see it working as a long-term stock holding. (Learn why it may be profitable to invest in beaten down stocks in Buy When There's Blood In The Streets.)

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