Shares of cloud-native data management company Snowflake (SNOW +0.92%) opened on the New York Stock Exchange with a bang on Wednesday. Trading started at $245 per share, despite being priced at $120 just one day earlier.
This opening price gave the cloud software specialist a market capitalization of about $68 billion -- an extraordinary valuation for a company with trailing-12-month revenue of just $403 million. Indeed, even Warren Buffett's Berkshire Hathaway (BRK.A 0.55%)(BRK.B 0.51%) is on this investment.
What should investors make of the market's excitement for Snowflake? Is Snowflake stock a buy?
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A great business model and incredible growth
It's certainly not surprising to see investors get excited about Snowflake. After all, the company has a lot going for it, from its attractive business model to its uncanny top-line growth.
Snowflake's cloud data platform helps its customers consolidate data to generate business insights, power data-driven applications, and create shareable information. Investors are particularly fond of the company's consumption-based business model, which creates a powerful recurring revenue stream. This, of course, puts Snowflake squarely in the middle of the market's growing appetite for fast-growing software-as-a-service (SaaS) companies.
Even more, Snowflake's management believes its platform benefits from a network effect in which every additional customer makes its solutions increasingly valuable. "The more customers adopt our platform, the more data can be exchanged with other Snowflake customers, partners, and data providers, enhancing the value of our platform for all users," reads the company's S-1 filing.
Both Snowflake's customer count and revenue are soaring. Total customers were 3,117 as of July 31, 2020, up from 1,547 one year earlier. Additionally, Snowflake is making inroads with major customers, counting seven of the Fortune 10 as customers and 146 of the Fortune 500. For the fiscal year ending Jan. 31, 2020, Snowflake's revenue was up 174% year over year. Revenue in the company's most recent quarter was up 121% year over year, with a customer net revenue retention rate of 158%.
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Valuation matters
All of this sounds great. But here's the big catch: price.
With the stock trading at about $270 at the time of this writing, Snowflake's market capitalization has soared to about $75 billion. This gives the company a price-to-sales ratio of 183. How does this stack up against some other hot tech stocks? Shopify, Zoom Video Communications, and Peloton Interactive have price-to-sales ratios of 53, 84, and 16, respectively. In other words, the market's exuberance for the stock may have already priced in Snowflake's long-term upside potential.
I'd go as far as to argue that even though Berkshire Hathaway recently bought a stake in Snowflake, the Oracle of Omaha's investment holding company wouldn't be interested in the fast-growing SaaS stock at this level.
Investors should keep in mind that Berkshire was likely able to get its hands on Snowflake at much lower prices than the $270 level that shares are trading at now. Berkshire's bid for Snowflake stock almost certainly received priority in its execution over market orders from individual investors, giving Buffett's company a lower average cost basis than retail investors are getting. Ahead of its IPO, Snowflake disclosed that it would sell shares to Berkshire Hathaway as part of two concurrent private placement rounds. Berkshire was slated to purchase $250 million worth of stock in a private placement and additional shares at the time of the IPO for a total stake in the company of about 2.6%.
So, should you buy shares? If you're up for speculating with a tiny percentage of your money, then maybe. Otherwise, investors may want to stay away from this stock at this price no matter how exciting the underlying business is.
