Winter may have arrived, but data warehouse provider Snowflake (SNOW 0.98%) remains a red-hot name on Wall Street. Snowflake, which boasts Salesforce.com and Warren Buffet's Berkshire Hathaway as investors, went public in September 2020 and recorded the largest software IPO in history. Since its public offering, revenue growth has exploded and Snowflake's market capitalization has climbed 41% to $99 billion. As growth stocks continue to battle market volatility, let's dig in and see if Snowflake is a good buy as we head into the new year.
Data is the new oil
Snowflake provides cloud-based data warehouse solutions to large enterprises such as Capital One, Anthem, and Twilio. The impacts of the COVID-19 pandemic underscored the importance for businesses to embrace flexible cloud computing solutions. Data warehouses serve as a critical component of systems management by providing short-term stability within an enterprise, while scaling for the long-term as businesses collect, store, and analyze more data.
According to Research And Markets, the global data warehouse-as-a-service market is expected to grow at a 22% compound annual growth rate and reach $13 billion by 2026. Moreover, Snowflake's latest investor presentation suggests that its total addressable market, capturing both data warehousing and cloud data platforms, is $90 billion. Snowflake has been a beneficiary of a large and growing addressable market and its financial results prove it.
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Robust financial profile or market euphoria?
For the fiscal quarter ended Oct. 31, 2021, the company boasted over 5,400 customers and 173% net revenue retention. What may be even more impressive is that Snowflake's revenue of $334.4 million represented 110% year-over-year growth. Moreover, the company's guidance for total revenue in 2021 was $1.1 billion, representing 103% growth over calendar 2020.
Although its large addressable market provides Snowflake with a greenfield opportunity, it also empowers new competitors to enter the market. As enterprises invest in digital transformation, Snowflake has doubled down on its product development and marketing efforts to beat the competition. For the nine months ended Oct. 31, 2021 Snowflake's sales and marketing costs were $540.7 million, representing 65% of total revenue and an increase of 66% over the same period in 2020. Additionally, research and development expenses were $343.8 million, which represented 41% of total revenue and a 139% year-over-year increase.
Investors could argue that these investments have generated superior, tripe-digit revenue growth. However, the company's financials show that as revenues have increased, so have its losses. Although the company generated $835.6 million in total revenue through the first nine months of 2021, Snowflake spent over $1.0 billion in operating expenses leading to an operating loss of $563 million. What could be even more concerning is that this loss is significantly higher than the same period in the prior year, in which the loss was $343.5 million. Despite sticking in the red, the stock still increased 20% in 2021 and as of this writing is trading at 107 times its trailing-12-month revenue.
Is the valuation premium justified?
At face value, it may appear that there is a disconnect in Snowflake's underlying fundamentals and its valuation. Perhaps investors view the current investments as a near-term sacrifice on profitability in order to achieve management's long-term vision of $10 billion in annual product revenue.
Even so, with a market capitalization hovering around $100 billion, it is reasonable for investors to exercise some caution when considering investing in Snowflake. For context, public competitors such as Datadog (DDOG -0.95%) and C3.ai (AI 3.84%) trade for 60 times and 17 times trailing-12-month revenue, respectively.
Despite recent compression in valuation multiples, especially in high-growth software stocks, Snowflake still appears to be trading at a premium compared to some of its peers. Furthermore, the company's aggressive spending in product development and marketing may need to be adjusted as we head into a year poised for rate hikes.
All eyes on the Federal Reserve
The Federal Reserve recently announced that it will begin tapering its bond buying activity and that 2022 will come with at least three interest rate hikes. A rising interest rate environment means that the cost to borrow money will become more expensive for companies.
For growth-oriented businesses like Snowflake, this dynamic could have a significant impact on free cash flow. Although the exact timing of these rate hikes are variable, investors already know that Snowflake is currently operating at a loss, and that rising rates could hurt its ability to invest aggressively and follow its growth roadmap.
Now what?
Snowflake is expected to release fiscal Q4 and full year 2021 results in March. At this time, investors should learn how close the company performed against its prior guidance, and perhaps more importantly, what it expects for 2022 in terms of revenue growth and operating profits.
Although the future prospects of the business look bright given its increasing addressable market and triple-digit revenue growth, the company continues to operate at a loss. With interest rate hikes on the horizon, it may be most prudent for investors to assess how Snowflake stock performs once the Federal Reserve institutes its new policies before initiating or adding to an existing position in 2022.
