To complement my colleague's article "SAP: Deutsche Qualität", I'd like to return to the relevance of investing in the company at its current price. After a spectacular and historically rather rare run on the German stock, it seems legitimate to ask the following question: should you take profits on the share?
Indeed, while SAP 's share price seemed depressed in September 2022, when it was trading below 80EUR, it has recently soared to EUR 223.2, i.e. +181.51% in just over 2 years.
At first glance, this is a staggering performance for a German large-cap that has historically accustomed us to rather modest growth. If we look at the last decade (2014-2023), sales rose at a rate of 5.9% a year, while net income gained an average of 6.1%. And you know that sooner or later, share prices inexorably follow earnings per share growth.
To understand SAP's recent track record, it's better to look at (expected) future growth. There are currently a lot of expectations about the company, in particular its integration of artificial intelligence solutions into its cloud offerings, which has been a key driver of its recent growth.
Buoyant momentum
For the third quarter of 2024, SAP reported sales of €8.47 billion, up 9% year-on-year. Attributable net profit came to 1.44 billion euros, exceeding analysts' forecasts. Operating profit rose by 28% to 2.24 billion euros. This performance was mainly due to strong growth in cloud revenues, which jumped by 27% to 4.35 billion euros.
On the strength of these results, SAP has raised its forecasts for 2024. The company is now targeting sales of between 29.5 and 29.8 billion euros for its software and cloud activities, with operating profit expected to be between 7.8 and 8 billion euros. Cash flow should also increase, with forecasts of 3.5 to 4 billion euros.
Profitability momentum looks likely to continue, with better scale in the cloud and earlier restructurings leading to improved operating leverage. Although board changes and ongoing investigations present uncertainties, risks to favorable structural developments at SAP appear minor.
SAP maintains a leading position in the ERP software market, particularly with large corporations. The company's efforts to promote the transition from conventional ERP software to its cloud subscriptions are showing signs of success. Company projections have been revised upwards, reflecting recent favorable profitability developments.
Valuation
At the current price of 218 euros per share, SAP presents a high valuation, with a price/sales ratio (P/S) of 7.6 and an expected price/earnings ratio (PER) of 88 for the current financial year. Investors should be aware of the risks associated with such a valuation, particularly in terms of earnings and cash flow multiples.
Historically, SAP has paid between 3.5 and 6 times sales and between 20 and 45 times net income. So we're well above the historical high-water mark for what is still modest growth. Do future growth expectations justify this valuation? In part, yes, but the upside potential (the margin of safety) on multiples is non-existent at the current price. The risk seems too great to invest in today.
SAP, which single-handedly carries the German DAX, has great momentum. But sometimes, a very demanding valuation based mainly on very high expectations must necessarily call for vigilance.
