Salesforce remains a buy due to cheap valuation and upside potential, despite underlying risks regarding pricing power and future AI growth deceleration.

software has gotten so cheap that there was a point where Salesforce stock, which we have exposure to, we sent a buy alert out on Salesforce specifically when it was about $165 because it had about a 13% free cash flow yield.

And Mark Beni off literally raised $26 billion of debt to buy back $25 billion of stock at about $191. So we looked at that setup and we're like this thing's trading for like a 0.9 peg.

Uh that's a price to earnings growth ratio. We can buy it at 165 for less than what the CEO just bought it back for.

And even though the bottom's not in yet, when it comes, it'll probably be pretty aggressive given how cheap the valuation is. And so Salesforce is just an example of that bottoming happening in software.

But it's not just Salesforce that skyrocketed. I mean, you can see when we bought at around 165 in this lower range over here, it fell more. It fell down to 146. But we since the the third quarter roughly the third quarter which started right here in July since the third quarter we had this almost perfect rise in not just Salesforce but another one that we own of exposure to which is Palunteer.

See tokens we know because when you look at margins for companies whether it's at Salesforce or at UiPath or at Palunteer tokens are increasingly costing these software companies money as they integrate tokens into the services that they're offering.

I've got Salesforce with a fair value of 458, which is still a double from here.

They bring in and enable tools that you could pull data from and use whether they're stored workflows or API access, database access, Salesforce access, or whatever.

This is true at Salesforce.

A company that Salesforce integrates with, Lorraa, they seem to be a great winner.

So if we now jump into uh let's go to Salesforce's documents, we could get a little bit of color about where the red flags sit. So and keep in mind we own Salesforce. We're exposed to Salesforce, exposed to Palunteer.

Like we're up on these. We're really excited about them. We've been studying these software plays for months with our course members. And I do have obviously an upside bias on these, but I want to be clear.

I'm also going to be critical. So that's why I'm going to start with some of the red flags here.

If we jump into a red flag over here, we can see that Salesforce is telling us that their primary increase in revenue came from new business, which includes not only new customers, but also additional subscriptions from existing customers. that pricing was not a significant driver for revenues.

Now, that could cut both ways. I could say we're going to hook people now and raise pre raise prices later, or we could argue that we didn't want to take pricing because we didn't want to get people to cancel and leave us.

They didn't want the attrition. So, you don't take pricing and you just try to sell people more AI features without raising prices on the on the existing. That might be a sign of weaker pricing power. That is important.

In addition to that, uh they say here there was a decrease in the spend for professional services. Uh which you could see right here about a 4% decline in professional services.

Why? Because there was less demand for larger multi-year transformations. In my opinion, that's a red flag. That's a sign that what you're doing is you're basically taking this existing sponge and you're like, "We won't raise the prices because we don't want to lose them, but let's offer them more AI stuff and squeeze the sponge."

And to me, that kind of aligns with this announcement that they made regarding Claw Force, that Claw Force runs Salesforce headlessly through Claude. So Claude gets direct governed access to data 360, Tableau, Slack, all your Salesforce crap without leaving the chat.

I kind of call this the palunteering of your data. You have one layer that where you can interact with all this data and you get fed what you need when you need it. That's good cuz it's all in one place and then it reduces the lookup time for you actually trying to find data, update data, process data, and it lets you focus on making the decisions.

Obviously, there's a limit for how many decisions you really need to make, but you know, to me, this is good. It makes you more efficient when you do need data to make those decisions.

Well, what it means is if you're not really growing, are you really justifying these massive moves up in price? Probably for now. It doesn't mean it's going to last forever. At some point, companies might end up sort of, you know, if you're operating through clawed force.

Uh, you might end up just rebuilding the Salesforce stack, which is literally the reason all of these companies ended up selling off in the first place. Everybody thought people were just going to vibe code away the Salesforce and they won't need Salesforce anymore.

Right now, that's not true. But those seeds of pain still exist.

The good news is the company got really cheap and even though they barely beat the stock skyrocketed that operating margin came in at 34.1% versus 33.6%. That was a beat. But RPO RPO remaining performance obligations only grew 14% which was a slight miss.

Subscriptions beat but only by 28 basis points. So forecast for Q3 also beat at 11.46 billion, but only a 35 basis point beat. So it's like these weren't really good earnings in terms of expectation versus reality.

I think what happened is the reason we had these large candles is because these have gotten too cheap. They have gotten too oversold in the SAS apocalypse.

So let's look at the valuation for the company. You know, what's a company like this actually worth? Well, let's look at the income statement. So, if we look at the income statement, we can actually see that gross margins compressed a bit.

We went from gross margins at 80, this is this would be 83.1%. Once you minus one on it, 83.1% compression down to 81.4%. Gross margin declined. Therefore, revenues are only growing at 10.8% year-over-year.

Stable, better than obviously shrinking, but their costs went up 18%. So, you have shrinking PP here. And again, I'm saying this like I have this tendency of being critical, like really critical of the things that I'm exposed to.

I should just be the hypeman, right? But but I also want to look at the red flags because that's the reasonable thing to do. So you know when it's time to get out anyway, they're bringing 31% down to the net, which is really good.

When you're bringing 31% down to the bottom line, $3.5 billion out of 11.3 billion, you deserve like a 2.6 peg. And so if we actually do the valuation on that add a 2.6 peg times 10.5% projected EPS growth over the next four years times their earnings per share projected January at the end of the year 1671.

We get to a valuation of mid 400s and honestly it could probably reasonably hit the mid 400s and then just momentum boom past that. If you momentum boom past that that's when you a stop allocating and b maybe you set a trailing stop and it's time to get out.

But like why get out now? It's you're so early in the process. This thing's this puppy's just starting to boom, right?

Legora uses Salesforce for audit trails and governance and compliance, blah blah blah. the underlying concern that these companies and in the future can still optimize and replace Salesforce exists and going you know headless to integrate into claude kind of suggests that those underlying issues aren't going to go away and if there's ever a recession you know that's going to be the time maybe that the companies are like all right it's time to optimize for costs you know where can we cut

But another thing is at some point the growth from introducing artificial intelligence products slows as well. If we go back over here, I want you to see growth from AI is right here.

It is growing right now faster than the core business. The core legacy business is right here. So, I'll highlight it in orange. Agent Force apps, Agent Force only grew 7.6% year-over-year.

The headless and the data 360 AI stuff that grew 20%. So, you are getting more gains right now from selling those AI products to the existing customers. As long as that keeps growing, you could keep seeing this stock go up.

That's my expectation. Once that growth starts slowing down, that becomes your bigger red flag.

So that's the income statement. Uh that's where the income's coming from. If you look at the balance sheet, we do have long debt, $45 billion, mostly financed at about one and a half% greater than treasuries.

That's your spread, your yield spread. And then about 25 billion was used to uh buy the dip on their own stock at about $191 per share. They have enough cash to pay their bills and their cash flow yield is still good.

They are yielding about 7% right now. And even if this stock gets fully priced at about $450, it would still yield a 3.5% cash flow yield, which is way better than the 1-ish% that Palanteer yields or the less than 1% that uh CrowdStrike yields.

So SAS recovery Q3 Q4 bottom. Yeah, it's definitely happening which is great and I'm really happy for that. I'm grateful for that. Can it keep going? Like is it too late to get into Palunteer or Salesforce?

My opinion the answer to that is no. I think these guys can still go.

But if you're going to get into those stocks, you have to look at them as they still have underlying red flags. some of the ones that you should pay attention to. Obviously, we've talked about here.

Uh those are the ones that I'm paying attention to. You might have your own red flags that you look at. Uh and and that's how you can have an exposure to this while still being uh careful, if you will.

It's still an investment, right? Don't get married to it.