Snowflake's (NYSE:SNOW) recent IPO attracted some big investors, including Warren Buffett's Berkshire Hathaway (NYSE:BRK.A) (NYSE:BRK.B) and salesforce.com, who were drawn to the company's triple-digit sales growth, sticky ecosystem, and disruptive approach to data storage and analytics.
Snowflake's revenue rose 174% in fiscal 2020, then grew another 133% year over year in the first half of 2021. Its net retention rate -- which gauges its ability to retain its existing customers, gain new ones, and cross-sell new services -- hit 158% over the past six months.
Those dazzling growth rates likely caused many investors to overlook Snowflake's net losses, which widened in 2020 and only narrowed slightly in the first half of 2021, and its trailing 12-month price-to-sales ratio of more than 160, which makes it one of the tech sector's priciest stocks.
It would be foolish to ignore those red flags, but the worst mistake Snowflake investors can make right now is to call it a "Buffett stock" like Coca-Cola or American Express.
Did Warren Buffett really choose Snowflake?
Warren Buffett famously avoided tech stocks throughout most of his career, but Berkshire gradually took stakes in companies like IBM, Oracle, Apple, Amazon, and VeriSign in recent years.
Berkshire subsequently sold its stakes in IBM and Oracle, but remains invested in Apple, Amazon, Verisign, and several other tech companies. However, many of Berkshire's tech investments were likely chosen by Berkshire's portfolio managers, Todd Combs and Ted Weschler, instead of Buffett himself.
During a CNBC interview last year, Buffett said that "one of the fellows in the office" was responsible for Berkshire's investment in Amazon. The Wall Street Journal also previously credited Berkshire's purchases of Apple and VeriSign to Combs and Weschler instead of Buffett. Therefore, it's highly likely Combs and Weschler also chose Snowflake, while Buffett only passively oversaw the investment.
The valuations still matter
Combs and Weschler are talented portfolio managers, but Berkshire's stake in Snowflake contradicts Buffett's evergreen mantra regarding value investing: "Whether we're talking about socks or stocks, I like buying quality merchandise when it is marked down."
Berkshire bought $730 million in Snowflake shares at the IPO price of $120 -- which included $250 million in new IPO shares and the rest from an existing shareholder. But even at its IPO price, Snowflake was valued at about $33 billion, or just over 80 times its trailing 12-month sales.
That was already a nosebleed valuation for the stock, but it subsequently more than doubled on the first day. Some investors might claim that valuations don't matter that much for high-growth cloud stocks, but Snowflake is now valued like a cult stock instead of a growth stock.
The value of Berkshire's stake in Snowflake soared, but investors who didn't secure any IPO shares have probably seen limited gains or even losses since its public debut. I also firmly believe Buffett and his money managers wouldn't touch Snowflake at its current valuation.
What should investors be paying attention to?
Instead of focusing on Berkshire's investment in Snowflake, investors should identify the main tailwinds and headwinds for the company.
Snowflake's platform breaks down data silos across large companies and pulls that information onto a unified system, which can be easily accessed by third-party data visualization software. Demand for its software is robust: Its total number of customers more than doubled year-over-year at the end of July, and it now serves 146 of the Fortune 500 companies.
But Snowflake's main weakness, besides its lack of profits, is that it runs on top of public cloud platforms like Amazon Web Services (AWS) and Microsoft Azure, which both promote similar data gathering platforms (AWS Redshift and Azure SQL Data Warehouse) that compete against Snowflake.
If push comes to shove, both tech giants could aggressively bundle their services with their cloud platforms at lower rates -- which could dampen Snowflake's chances of ever turning a profit. If Snowflake's losses widen as its revenue growth decelerates, its stock could quickly lose its luster.
The key takeaways
Berkshire Hathaway has outperformed the S&P 500 by a wide margin over the past two decades, but investors should be wary of chasing the company's latest investments without doing their due diligence.
Many of Berkshire's recent investments, including Snowflake, don't abide by Buffett's classic rules for investing, so investors shouldn't automatically consider the Oracle's seal of approval as a green light to buy a stock.