This is an article that might be a bit difficult for you to read -- it was very difficult for me to even write it.

The company I’m going to discuss is one that I think is in a unique market, has helped to redefine an industry, and has a lot of potential going forward. But, with that said, I also think the company is terribly overvalued. If you were one of the earlier investors in this company, then I’m sure this company holds a special place in your heart. Its stock has given investors a return of over 100% in less than two years.

You may have been one of those people who invested in Salesforce.com (SYM: CRM) when it first began trading in the summer of 2004. In that case, your investment has obviously done very well for you. But if you’re one of those people who are thinking about investing in the company at today’s prices, do yourself a favor and think again.

Business Overview

First, let me talk to you a little bit about the business itself ...

Basically, SalesForce.com provides Customer Relationship Management (CRM) software for businesses. What makes the company unique is that it allows these businesses to use the software over the web (as opposed to having a downloaded program on your computer). This allows companies to run the software for less money than traditional CRM software. On top of that, they have the convenience of not having to manage the software on their own servers.

This is what allowed SalesForce.com to double sales each year for the past two years. I’ve used their system myself. It’s very user friendly and definitely gets the job done. Salesforce.com is also a pioneer in this space, and has captured significant market share from old-line CRM players such as Siebel systems (recently acquired by Oracle).

So you may be asking, “OK, Wayne, then what’s wrong with buying the stock?”

 Risks

Well, as you’ve heard me say many times in the past, before I buy any stock, I ask myself two questions:

1. What is this company worth?
2. What do I have to pay for it?

If I need to pay more than 60 cents on the dollar for a business, then I simply won’t invest in it. So let’s take a look at SalesForce.com’s financials for the latest fiscal year:

• For FY 2005, the company earned a little over $7 million.
• The year before, it was earning about $3.5 million.

Doubling earnings is certainly an impressive feat -- but we also need to consider the fact that, as recently as 2003, the company was still losing money, so it lacks any real track record of sustained profitability and earnings growth. Even if we assume that they can continue a positive earnings trend, we then need to examine what will happen once competitors begin to flock into this space. If you knew the guy down the street was making $1 million a year selling lemonade in front of his house, you’d start selling lemonade too, right?

 Competitors

Aside from the obvious competitors such as Siebel systems, SalesForce.com is going to face competition from upstarts that are just as nimble as SalesForce is.
One in particular, Entellium, was recently featured in a Business 2.0 article. Now, here is a company that simply copied what SalesForce.com was doing, but did it better and cheaper. The company hired video game designers to make its interface more useable. And, since it’s a smaller company with lower fixed costs, it was able to offer steep discounts - sometimes it charges as much as 40% less than SalesForce’s prices. This is allowing Entellium to attract new customers, and take some away from SalesForce.com in the process.

 The Bottom Line ...

Combine all this with the fact that Salesforce.com’s market capitalization is roughly $4 billion (on $7 million in earnings), and you can see why I’m a bit nervous.
Its stock is carrying a P/E ratio of 152! Even for a high-growth tech company, that valuation is a bit rich.

So I’m not suggesting you run out there and short the stock -- but if you currently own shares, I’d certainly take some profits off the table. And if you’re seriously considering taking a position in the company now, I’d strongly advise against it.

Until next time, folks ...