Snowflake (NYSE:SNOW) was one of the hottest tech IPOs of 2020. The cloud services company went public at $120 last September, more than doubled on the first day, and hit a 52-week high of $429 in December.
At its peak, Snowflake was valued at about $120 billion — more than 200 times its revenue in fiscal 2021, which ended this January. That nosebleed price-to-sales ratio was a bright red flag, and the stock subsequently tumbled back to about $240 as investors rotated out of growth stocks.
That sell-off burned a lot of bulls, but does it represent a fresh buying opportunity for patient investors who can stomach the volatility? Let’s take a fresh look at Snowflake’s business to find out.
Why did Snowflake attract so much attention?
Large companies often store their data across different computing platforms and silos. Analyzing that data can be a time-consuming and inefficient process, so Snowflake simplifies the process by pulling all that information onto a centralized cloud-based platform.
Companies can then view that data with their own apps or third-party visualization services like Salesforce‘s (NYSE:CRM) Tableau. This disruptive approach impressed companies like PepsiCo and Kraft Heinz, and attracted big investors like Warren Buffett’s Berkshire Hathaway and Salesforce.
How fast is Snowflake growing?
Snowflake’s total number of customers jumped 73% to 4,139 at the end of fiscal 2021, including 186 of the Fortune 500 companies.
Snowflake’s total revenue rose 124% to $592 million in 2021. Its net retention rate, which measures its year-over-year revenue growth per existing customer, exceeded 165% for the full year.
In the first quarter of fiscal 2022, Snowflake’s revenue rose another 110% year over year to $228.9 million. Its number of customers increased 67% to 4,532, including a new Fortune 500 customer, and it ended the period with net retention rate of 168%.
Snowflake expects its product revenue, which accounted for 94% of its top line in fiscal 2021, to increase 86% at the midpoint in fiscal 2022. Wall Street expects its total revenue, which includes its fees from professional services and other businesses, to rise 88% to $1.11 billion.
Based on that forecast, Snowflake’s stock trades at about 60 times this year’s sales — which still makes it pricier than most of the market’s highest-growth tech stocks. The bulls will argue that Snowflake’s stellar growth rates justify that premium, but the stock could face an uphill battle as rising bond yields and inflation fears rattle the tech sector.
Lots of red ink and tough competitors at the gates
Snowflake’s top-line growth is impressive, but its net loss widened from $348.5 million in fiscal 2020 to $539.1 million in fiscal 2021. That trend continued in the first quarter of 2022, as its net loss more than doubled from $93.6 million to $203.2 million.
Snowflake’s non-GAAP gross margins have been expanding since its IPO, thanks to better cloud infrastructure deals, its increasing scale, and its decreased usage of discounts. However, its stock-based compensation expenses still consumed a whopping 73% of its revenues in the first quarter of 2021 — compared to just 21% of its revenues a year ago.
That ratio will likely remain high as Snowflake prioritizes the expansion of its workforce over its near-term profits. Its number of outstanding shares will also continue rising and keep its valuations elevated.
Snowflake’s lack of profits could also leave it vulnerable to competitors like Amazon‘s (NASDAQ:AMZN) Redshift and Microsoft‘s (NASDAQ:MSFT) Azure SQL Data Warehouse. That’s ironic, since Snowflake’s platform runs on Amazon Web Services (AWS) and Azure — which means it actually rents cloud computing power from its biggest competitors.
Amazon, Microsoft, and other big tech companies can afford to offer their data warehousing solutions at cheaper rates than Snowflake — which could make it tough to ever turn a profit.
Snowflake is still too expensive
Snowflake is a disruptive company that carved out a high-growth niche in the crowded cloud services market. But its days of triple-digit revenue growth are gradually ending, and there’s no clear path toward profitability as Amazon, Microsoft, and others try to catch up to Snowflake.
Snowflake’s growing list of Fortune 500 customers and high net retention rate indicate it has a wide moat, but its stock has arguably been overpriced since its IPO.
Therefore, investors should stick with tech companies that are more reasonably valued relative to their growth rates for now, then revisit Snowflake after its price cools off in this challenging market.
This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.