The Great Divide In Technology Stocks
There is a great divide taking place in the land of technology stocks. The “New Guard” of technology companies have a cloud computing, recurring or transactional revenue story with promotional leaders and great spin. The “Old Guard” of technology companies have big brands and huge presence among customers, but are viewed by some as stodgy and tired. Here’s how the public markets are valuing these two sets of companies from a P/E ratio perspective:
The New Guard
- Salesforce.com – 259
- VMware – 136
- Rackspace – 107
- RedHat – 91
- F5 Networks – 77
- Amazon.com – 74
- Netflix – 72
- Akamai – 60
Median P/E ratio of “New Guard” Companies: 84
The Old Guard
- Oracle – 23
- Cisco – 15
- eBay – 14
- IBM – 13
- Dell – 13
- Microsoft – 12
- Intel – 11
- Hewlett-Packard – 12
Median P/E ratio of “Old Guard” Companies: 13
Is it fair for the New Guard to trade at a median P/E ratio that is 6.5 times higher than the Old Guard? I don’t think so – it will not last. It’s not to say that the Old Guard is undervalued, but eventually, the New Guard will come back to earth. Eventually, the New Guard companies will trade at less than a 25 P/E ratio – it’s the law of gravity in stocks (consider that even Apple trades at a 23 P/E). Given that, in the case of Salesforce.com, that means its P/E ratio will decline by 90% from where it is today. The question is whether that multiple compression happens because earnings actually grow by 10 times, or because investors get more valuation conscious, or both. Only time will tell.
Thinking About Thinking 
I agree with your listing here. Now that I see them listed out, its interesting that all these ‘new guard’ companies are the ones best positioned to make optimal use of the cloud….
Is there an emerging guard of technology companies which you expect may reach median P/E ratios of 84 in the next 1-3 years?
Hi Larry, late to the conversation here, and just catching up on your blog. It’s interesting to think about current and future valuation discrepancies in your “Old v New”, especially enterprise software. The SAAS model is obviously brutal on cash flow– Salesforce needed $1B in revenue just to print a profit.
Looking at CRM’s fiscal ’11 ended January– they did $100M in operating income on $1.66B revenue. Revenue grew 28%. And they spent 50% of revenue on Sales/Marketing.
Oracle did $27B (2010 ended May, so different time period, but close enough for big-picture), and op income at $9B. Revenue grew 15%. Oracle spent 20% of revenue on Sales/Marketing.
I wonder how much of CRM’s Sales/Mktg expense is related to growth vs retention. On-prem vendors have to deal with retention too, but the ROI for an on-prem vendor sales cycle is higher and more immediate. A new sales cycle at the same customer every 5-7 years means the same cashflow hit all over again for a SAAS vendor.
Also, I wonder how average deal size, measured in seats, compares. My guess is that CRM is dealing with smaller customers and smaller seat counts on average vs competition. This can be tough on margins too, for a direct sales operation.
Pete