As the world becomes more digitally connected, enterprises are increasingly depending on data to deliver value. In turn, data-guru companies Snowflake (SNOW 1.21%) and Palantir Technologies (PLTR 2.44%) have garnered a lot of attention from Wall Street. However, following a heavy sell-off in technology stocks in the final months of 2021, both companies have retreated from prior gains despite impressive growth. Let's dig in and see which software leader may serve as a better long-term investment for investors.
Data is the new oil
Snowflake and Palantir operate overlapping markets and aim to help solve the same issues. Namely, both companies create software tools that allow enterprises to derive data-driven insights from disparate systems. According to research from IDC, over 80% of enterprise data will be unstructured by 2025. This means that customer records housed in a customer relationship management (CRM) system or financial data stored in an enterprise resource planning system are disconnected and incongruent with one another. As the world becomes a more connected place and data becomes a pillar of an enterprise, the need for digital transformation is rising.
Large corporations have options to choose from when it comes to storing and analyzing data. Data-warehouse-as-a-service company Snowflake, which recorded the largest software initial public offering (IPO) of all time in September 2020, is becoming a market leader in data analytics.
Per the company's third-quarter 2021 results, a surge in demand is driving explosive growth in several key performance indicators. For the fiscal quarter ended Oct. 31, 2021, Snowflake reported over 5,400 customers and 173% net revenue retention. Moreover, the company's revenue grew 110% year over year to $334.4 million.
But Snowflake is not the only technology company vying for the top spot in big data. Secretive data analytics company Palantir also went public in September 2020 after spending two decades as a private company.
Palantir's flagship product, Foundry, aims to serve as the connective layer between analytics and operating systems. Although Palantir is not experiencing the same level of triple-digit revenue growth as Snowflake, its Q3 2021 financials indicate major momentum. Palantir reported $392 million in revenue during Q3 2021, representing 36% year-over-year growth. The company concluded Q3 earnings indicating full-year 2021 revenue growth of 40% and outlined a commitment to grow revenue by 30% or more for the next four years.
Although Snowflake may appear the better investment opportunity in terms of top-line growth, investors should remember that revenue alone does not tell the full story when evaluating a stock.
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It takes money to make money
Despite its impressive revenue growth, Snowflake pays a big price to acquire its customers. Through the first nine months of calendar year 2021, Snowflake spent $540.7 million on sales and marketing costs, representing 65% of total revenue and a 66% year-over-year increase. Research and development expenses represented 41% of total revenue and increased 139% year over year. Although Snowflake generated $835.6 million in total revenue through the first nine months of 2021, the company spent over $1.0 billion in operating expenses.
The notion of sacrificing short-term profits by investing in the business certainly has merit. However, in Snowflake's case, the company's operating losses are significantly higher compared to the same period in the prior year.
On the other hand, Palantir has approached customer acquisition differently. The company employs an acquire, expand, and scale sales model, which means Palantir assumes the costs associated with a trial during the acquire and expand phases. As such, the initial acquisition of customers runs at a loss for Palantir. It is not until the customer enters the scale phase that contribution margins turn positive.
On the surface, it may seem counterintuitive to lose money on a contract. However, Palantir's financial profile is signaling that this strategy is working. According to its Q3 2021 investor presentation, Palantir is scaling its average revenue per customer, which, in turn, is fueling margin expansion. During Q3 2021, Palantir reported a contribution margin of 57% compared to 56% in Q3 2020.
This margin expansion is dropping down to the bottom line in the form of increased cash flow. Through the first nine months of 2021, Palantir's operating cash flow was $240.4 million compared to a negative $278.3 million for the first nine months of 2020.
While Snowflake has prioritized new customer acquisition, the company's financials signal that it is willing to outspend the competition for the sake of top-line revenue growth. Palantir's methodology of assuming up-front costs with the aim to "land and expand" the average deal value over time is beginning to pay positive dividends in the form of increased cash flow.
Which is the better buy?
Revenue and expense profiles are important when evaluating an investment. In the cases of Palantir and Snowflake, there is one other metric that really underscores the potential growth for these two data analytics providers. Per the company's Q3 2021 financials, Snowflake's remaining performance obligations (RPO) grew 94% YOY to $1.8 billion. By comparison, Palantir's RPO increased from $321.6 million in Sept. 2020 to $873.9 million in Sept. 2021, representing over 170% year-over-year growth. RPO is an important key performance indicator for the momentum of a business. For recurring revenue businesses, the pace at which future revenue momentum is growing can serve as a valuable sign for the prospects of the business.
At the time of this writing, Palantir trades for roughly 25 times its trailing 12-month sales compared to Snowflake's 107 times. Although both companies offer unique, industry-leading solutions, Palantir's sales strategy appears to have established a more robust financial profile for long-term success. As the company expands margins, it should be able to reinvest this influx of capital into product development. While Palantir hovers near a 52-week low, the fundamentals suggest that now may be a good time to buy Palantir on the dip. On the contrary, investors may want to assess Snowflake's future earnings, namely its path to profitability, before initiating a position.
