How Do R&D Expenses Impact Salesforce’s Stock Price?

Cloud computing behemoth Salesforce‘s (NYSE:CRM) revenues continue to grow by over 20% year over year, primarily due to strong performance of its cloud offerings. The constant evolution of Salesforce’s offerings, along with the need to integrate newly acquired products, has resulted in an increase in the company’s research and development (R&D) expenses.

Additionally, Salesforce has been on an acquisition spree and has acquired more than 10 companies in the current calendar year. The acquisitions have helped the company evolve its current offerings in the sales cloud, service cloud and marketing cloud. Moreover, the company’s acquisition of Demandware (now called as Salesforce Commerce cloud) and its new product – Salesforce Einstein – has accelerated the company’s foray into the e-commerce and artificial intelligence domains, respectively.

The new offerings and constant upgrades of existing offerings have driven Salesforce’s R&D expenses which, in absolute dollar terms, have increased year over year. Additionally, the integration of newer acquisitions into the existing offerings have also impacted R&D expenses. Despite the increase the R&D expenses, as a percentage of gross profit these expenses have remained relatively consistent. Going forward, we expect the expenses as a percentage of revenue to remain at similar levels.

Currently the R&D expenses as a percentage of gross profit are 14.5%. Going forward, as the company continues to mature and grow revenues, its R&D spend will likely decline both on an absolute dollar bases and as a percentage of gross profit.

However, if the company continues to increase its R&D spend in order to widen the gap between itself and its competitors and integrate newer acquisitions, there could be a downside of around 7% to our price estimate for Salesforce’s stock.

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