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3 Questions to Ask Yourself Before Buying Snowflake's IPO

By Billy Duberstein - Sep 14, 2020 at 8:12AM

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Investors' mouths are watering over this high-growth cloud stock. But before you buy, you need to answer these questions.

Investors young and old have become enthusiastic about the upcoming initial public offering for Snowflake. The cloud-based data warehouse provider has been one of the highest-profile unicorns (private companies with valuations over $1 billion) in Silicon Valley for years now. Warren Buffett's Berkshire Hathaway (BRK.A 0.56%) (BRK.B 0.46%) recently disclosed it would be buying some $570 million worth of stock upon Snowflake's IPO and salesforce.com (CRM -1.00%) said it would throw in $250 million just for good measure, sending interest in Snowflake off the charts.

The stock is set to go public Tuesday, Sept. 15, at a price between $75 and $78 per share, valuing the company around $23 billion. But before diving in, investors need to ask themselves the following questions to make sure an investment in Snowflake's IPO -- and how much -- is appropriate.

Middle aged man in glasses tie and a vest holds cash in his hand.

Does Snowflake belong in your portfolio? Image source: Getty Images.

1. Does this stock fit in with my investing strategy, and if so, what allocation should I make it?

For Warren Buffett, who is traditionally known for safe value stocks and who has famously quipped even in recent years that he would never buy a new IPO, the investment in ultra high-growth Snowflake is a radical departure. It's highly likely that Buffett is not the one investing in Snowflake, but rather it's one of his investing lieutenants, Todd Combs or Ted Weschler, each of whom has complete autonomy over their respective portions of the Berkshire equity portfolio.

Unlike most Berkshire investments, Snowflake is a money-losing growth stock that doesn't pay a dividend. That means Snowflake's IPO is probably inappropriate for retirees or those nearing retirement, where one's primary concern should be the preservation of wealth and income.

Yes, Snowflake's 133% growth over the first six months of 2020 and 158% net retention rates are terrific. However, Snowflake will also be hitting the market at almost 60 times trailing-12-month sales -- an extremely high valuation. Yes, the company will probably make about $600 million during fiscal 2021 which ends in January, but that would bring the valuation to around 40 times sales, which is still quite high. Remember, as companies get bigger, the law of large numbers usually causes them to slow down markedly. Cloud technology stocks have soared this year to all-time high valuations amid the COVID-19 pandemic, so Snowflake is selling shares at a time when tech stocks are fetching historic premiums relative to their past.

I'm not saying that Snowflake doesn't deserve its valuation; however, at that price, there's an awful lot of good news baked in. And though you may think Snowflake has the "Warren Buffett seal of approval," consider this: Berkshire Hathaway's equity portfolio was worth $207 billion as of June 30, and is likely worth much more now. In addition, Berkshire had another $143 billion in cash and cash equivalents on June 30. In that light, the company's investment in Snowflake's IPO amounts to a paltry allocation of 0.16% of Berkshire's cash and equity investments. Berkshire also doesn't have any real exposure to cloud software stocks, so this could merely mark Berkshire's attempt to catch up with the rest of the high-flying tech market.

If you're a young investor with a whole life ahead of you to earn money and invest, then by all means, take a shot at this exciting company. However, the older and closer to retirement you are, the more reason for caution.

A picture of Warren Buffett looking pensive.

Image source: The Motley Fool.

2. Do I understand this company, or am I just buying because of others?

No doubt, Warren Buffett, his lieutenants, and even Salesforce have proven themselves to be savvy investors over time. But you shouldn't be investing in Snowflake merely because they are. You should be investing in Snowflake because you understand the company's product, competitive advantages, growth and market prospects, and management.

If you're new to Snowflake, where's a good place to start? Well, I wrote a quick rundown on Snowflake last week, and if that whets your appetite, you can always read the company's S-1 filing.

In short, Snowflake provides a service called a data warehouse, an existing product that companies have used for years in order to organize and make sense of their historical data to inform their decisions. Snowflake is unique in that it was the first company to optimize its data warehouse for fast cloud computing, allowing for easy interoperability among all three major public clouds.

Judging by Snowflake's growth rates, it appears to be disruptive to traditional data warehouse vendors; however, going forward it will also have to compete against the "private label" data warehouses each cloud company also sells to their customers. So far, Snowflake looks like a preferred option, but the more successful Snowflake becomes, the more these large, well-funded "frenemies" will look to get a piece of the action.

Leading the charge will be current CEO Frank Slootman, who has a great reputation as a very aggressive tech leader, with a track record of success at his former company ServiceNow (NOW -3.25%). You can find an informative interview with the Snowflake CEO from last year here.

A young man in a suit holds up a sign that says worth the risk?

Snowflake is likely to open higher than its IPO price. Image source: Getty Images.

3. At what price would I buy?

Say you've read through Snowflake's documents and concluded you are young or at least wealthy enough to allocate a portion of your portfolio to this stock. Then comes another conundrum: How much are you willing to pay?

Investors need to ask that question because often when stocks go public, by the time they hit the market for trading, the price has usually already shot up much higher than the offering price. Sure, it may seem unfair, but retail investors aren't likely to have $250 million or $500 million lying around with which to buy a substantial amount of stock at the offering price.

It's not always the case that IPOs open for trading much higher than the offering price, but in Snowflake's case, I think it's a fair assumption that public investors won't get the same deal as Berkshire or Salesforce. It's possible the stock could open 20%, 30%, or even 50% higher than the official IPO price.

Therefore, interested investors will have to ask themselves at what premium they would still be willing to buy shares. At $90? $100? $120? At any price? Only you, as an informed investor, can make that choice. However, once you've set a limit for yourself, try to be disciplined and stick to it. If you miss the stock on the way up, chances are you may have the opportunity to buy it at that price at some point down the road once the heat around Snowflake cools down.

Check, check, check? Good luck!

Remember, there are many stocks in the market that can make you rich, and all you have to do is find one. Snowflake may be one such stock, but there will also be others. When the hype around a new IPO is this great, it's important to stay disciplined and stick with the investing process that's right for you. Over the long haul, that's the strategy that will really pay off.

Billy Duberstein owns shares of Berkshire Hathaway (B shares). His clients may own shares  of the companies mentioned. The Motley Fool owns shares of and recommends Berkshire Hathaway (B shares), Salesforce.com, and ServiceNow, Inc and recommends the following options: long January 2021 $200 calls on Berkshire Hathaway (B shares), short January 2021 $200 puts on Berkshire Hathaway (B shares), and short September 2020 $200 calls on Berkshire Hathaway (B shares). The Motley Fool has a disclosure policy.

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Stocks Mentioned

Berkshire Hathaway Inc. Stock Quote
Berkshire Hathaway Inc.
BRK.A
$445,301.99 (0.56%) $2,501.99
Berkshire Hathaway Inc. Stock Quote
Berkshire Hathaway Inc.
BRK.B
$296.47 (0.46%) $1.36
Salesforce, Inc. Stock Quote
Salesforce, Inc.
CRM
$186.73 (-1.00%) $-1.88
ServiceNow Stock Quote
ServiceNow
NOW
$499.45 (-3.25%) $-16.75

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