Tickers in this Article: CRM, ORCL, IBM, SAP, GOOG
Arguing about the valuation and underlying fundamental quality of hot growth stocks is a lot like fighting the tides. While the market has shown time and time again that cash flow and valuation are ultimately all that matter, it can take a painfully long time for reality to supplant hope and hype. So although I fully expect Salesforce.com (NYSE:CRM) to post gaudy growth for some time to come, the underlying thesis and valuation still just don't work for me as an investor.

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Another "Strong" Quarter
In many respects, Salesforce.com offered the sort of quarter that it has for a while now - both bulls and bears will find points to validate their preexisting biases. Reported revenue rose 34% from last year (and 5% from the first quarter), as subscription revenue rose 35%. Although headline billings growth of 30% looked like a slowdown from the first quarter (where they grew 34%), adjusting out for currency and other factors lifts that number into the high 30s. Deferred revenue growth also looked strong at 46%.

The margin and profit performance still revolves around what you choose to prioritize as an investor. GAAP gross margin was basically flat with the year-ago level, while the company's GAAP operating loss was pretty much in line with last year as well. Non-GAAP operating income grew 60%, though. On an encouraging note, operating cash flow before working capital items did increase by more than one-third.

SEE: Analyzing Operating Margins

Does Buying Mean They Cannot Build?
One of the bigger recent developments at Salesforce.com was the acquisition of BuddyMedia for nearly $700 million in total consideration. Coming roughly a year after the Radian6 buy, Salesforce.com has spent about $1 billion to develop a strong and comprehensive cloud-based social media marketing platform.

Ostensibly, there's nothing wrong with getting bigger in social media. There's no reason to think that cloud-based marketing won't be a major market, particularly as rivals like Oracle (Nasdaq:ORCL) and Google (Nasdaq:GOOG) have spent hundreds of millions to build up their positions as well (with Vitrue and Wildfire, respectively).

I do wonder about the soundness of this long-term buy-in model, though. Acquisitions give ample scope for more "adjusted earnings" nonsense and also increase integration risk as more and more disparate systems need to work together. Plus, does it say anything about Salesforce.com's internal development capabilities when it needs to rely so heavily on acquisitions? Given how much companies like Oracle, SAP AG (NYSE:SAP) and IBM (NYSE:IBM) have relied on deals to build their business, I'd say the answer is probably "no", but it's a question worth asking.

SEE: Is Cloud Computing An Investable Trend?

Still Looking for Leverage in Sales
Now for the broken record portion of this article - Salesforce.com's apparent inability to achieve real marketing leverage. Salesforce.com continues to invest huge amounts of capital into expanding its sales and marketing capabilities. Marketing and sales spending jumped 34% from last year, and the company cannot seem to establish any real leverage. If this continues and Salesforce.com cannot leverage its sales efforts more effectively, I don't know how the Street can continue to support such a high multiple for the stock.

SEE: The Most Profitable Investing Trends Right Now

The Bottom Line
I'm realistic enough about the markets to know that 30% revenue growth makes up for a lot of sins in the eyes of investors. What's more, if estimates that only about 25% of CRM's spending is cloud-based are true, that suggests a huge remaining addressable market for Salesforce.com, to say nothing of the potential of moving from sales calls to enterprise CIO to the CMOs (social marketing, etc.). All of that said, I just can't get comfortable with a stock where it seems that the normal rules of business and value creation don't apply. Even if Salesforce.com can grow its free cash flow at a compounded rate of over 20% for a decade (a pretty phenomenal growth rate), the shares are not that cheap (fair value of around $150 on that cash flow growth).

At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.

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