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Is Snowflake Stock a Buy?

By Leo Sun – Aug 31, 2021 at 7:15AM

Key Points

  • Snowflake’s revenue more than doubled in the second quarter, but so did its net losses.
  • Management expects Snowflake's product sales to decelerate in the third quarter.
  • Snowflake management has high hopes for the future, but that optimism is already baked into its sky-high valuations.

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The cloud services company beats Wall Street's expectations again.

Snowflake's (SNOW -1.18%) stock price rose to a six-month high after the company posted its second-quarter earnings report on Aug. 25. The cloud-based software company's revenue rose 104% year over year to $272.2 million, beating estimates by $15.5 million. Its net loss widened from $77.6 million to $189.7 million, or $0.64 per share, but it still beat expectations by two cents.

Is Snowflake's stock still worth buying after its post-earnings pop? Let's dig deeper into its growth rates, challenges, and valuations to decide.

A digital illustration of a snowflake-shaped circuit.

Image source: Getty Images.

How fast is Snowflake growing?

Snowflake's cloud-based data warehousing platform collects data from a company's different computing platforms and software applications. It breaks down those silos and organizes the data in a centralized cloud-based location, which can be easily accessed by third-party apps and data visualization software.

Snowflake's platform runs on top of public cloud infrastructure platforms like Amazon (AMZN -0.77%) Web Services (AWS) and Microsoft's (MSFT -0.04%) Azure. AWS and Azure both provide their own integrated data warehousing solutions, so Snowflake is (ironically) paying its largest rivals.

Competing against Amazon and Microsoft seems daunting, but Snowflake's business is still firing on all cylinders. It ended the second quarter with 4,990 customers, up 60% from a year ago, and its number of customers generating over $1 million in annual product revenue more than doubled from 56 to 116. It served 216 members of the Fortune 500, compared to 158 members a year earlier.

Snowflake mainly gauges its growth in terms of its product revenue (94% of its top line in the second quarter), its net revenue retention rate, and its remaining performance obligations (RPO). All three of those core growth metrics have remained very high since its IPO last September:

Period

Q3 2021

Q4 2021

Q1 2022

Q2 2022

Product Revenue (YOY Growth)

115%

116%

110%

103%

Net Revenue Retention Rate

162%

168%

168%

169%

RPO (YOY Growth)

240%

213%

206%

122%

Data source: Snowflake. YOY = Year-over-year.

But Snowflake's growth is decelerating. It expects its product revenue to rise 89%-92% year-over-year in the third quarter, and its slowing RPO growth highlights a growing need to secure new contracts.

During the conference call, CFO Mike Scarpelli attributed Snowflake's slower RPO growth to a "difficult comparison" to the prior-year quarter -- when it secured its "largest multi-year contract ever" -- and warned that the future timing of its "largest multiyear deals will be lumpy."

Snowflake expects its product revenue to rise 91%-93% for the full year, compared to its 120% growth last year. Analysts expect its total revenue to rise 92% for the full year, but it should remain unprofitable on a GAAP basis for the foreseeable future.

High valuations, with high hopes for the future

Snowflake's stock seems very expensive at nearly 80 times this year's sales. But during its investor day gathering earlier this year, management predicted its product revenue would surge from $554 million in fiscal 2021 to $10 billion in fiscal 2029 -- representing a whopping compound annual growth rate (CAGR) of 43.6%.

The company believes roughly 1,400 of its customers will generate more than $1 million in annual product revenue by then, representing a 12-fold jump from its current numbers, and its average revenue from those top customers will increase from $3.4 million to $5.5 million. It also expects its adjusted product gross margin to expand from 69% in fiscal 2021 to 75% in fiscal 2029.

Snowflake expects the secular expansion of the public cloud services market, the growing need to break down silos and organize large amounts of data, and the expansion of its ecosystem with partnerships with other cloud, data, and AI companies to drive that growth.

However, Snowflake already trades at nearly nine times its estimated product revenue for fiscal 2029, so it's already priced for perfection -- and any deviation from its rosy forecast could torpedo its stock.

Over the next few years, Amazon and Microsoft could upgrade their data warehousing platforms, lower their prices, bundle them with other cloud services, or even hit Snowflake with higher hosting costs. Therefore, investors should be cautious and take Snowflake management's investor day targets with a grain of salt.

A good company with an overvalued stock

Snowflake's growth is still impressive, but its growth is decelerating, its stock is incredibly expensive, and its long-term forecast is too optimistic. I'd consider buying Snowflake if it gets cut in half during a market crash, but I'm not interested in chasing its post-earnings gains. Simply put, don't pay the wrong price for the right company.

John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Teresa Kersten, an employee of LinkedIn, a Microsoft subsidiary, is a member of The Motley Fool's board of directors. Leo Sun owns shares of Amazon. The Motley Fool owns shares of and recommends Amazon, Microsoft, and Snowflake Inc. The Motley Fool recommends the following options: long January 2022 $1,920 calls on Amazon and short January 2022 $1,940 calls on Amazon. The Motley Fool has a disclosure policy.

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Stocks Mentioned

Snowflake Inc. Stock Quote
Snowflake Inc.
SNOW
$144.72 (-1.18%) $-1.73
Microsoft Stock Quote
Microsoft
MSFT
$247.49 (-0.04%) $0.09
Amazon Stock Quote
Amazon
AMZN
$93.41 (-0.77%) $0.72

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