Snowflake (SNOW 0.73%) has been a hot stock since its initial public offering (IPO) in 2020, fetching a steep valuation for its stellar growth and high-profile backers, including Warren Buffett himself. Until recently, the stock's been reluctant to come off much from its rich valuation.
But after the company reported its earnings for the fiscal year (ended Jan. 31), investors reacted negatively to the news, selling the stock to within shouting distance of its all-time lows. Should investors buy the dip, or is Snowflake just beginning to melt? Here's what you need to know.
Was the quarter that bad?
The data infrastructure company put up some excellent numbers on the surface. Revenue grew 101% year over year in the latest quarter to $384 million and by 106% for the full fiscal year to $1.2 billion. Management also announced that it had $2.6 billion in "performance obligations" -- that is, business under contract that will be counted as revenue once it renders those services.
Image source: Getty Images.
Additionally, the number of customers spending $1 million or more on Snowflake grew 139% year over year to 184, and the company now has 5,944 total customers. The business model is primarily usage-based, which results in a very high net revenue retention rate (NRR) of 178%. This number indicates how much more customers are spending once onboard the platform, and Snowflake's NRR is among the highest on Wall Street.
Lastly, Snowflake's gross profit margin rapidly expanded, improving to 74% from 69% a year ago. Free cash flow grew nearly fivefold over the past year to $102 million, so Snowflake is seeing its financials begin to improve rapidly, even if it's technically still losing money on the bottom line. Overall, it seems like Snowflake is a quality business, growing and moving its financial metrics in the right direction.
High valuation sets high expectations
So what caused the market's adverse reaction? It could be that management guided for 66% revenue growth for the upcoming fiscal year. Going from 106% revenue growth to 66% growth is a notable slowdown, and even if management is being conservative, there isn't much room for error when you're valued so richly.
Snowflake has been among the most expensive stocks in the market since its IPO, trading well over a price-to-sales (P/S) ratio of 100 at one point, as seen in the chart. The stock's valuation has come down considerably thanks to a sell-off but is still very steeply priced at a P/S of 64.
SNOW PS Ratio data by YCharts
Ultimately, high valuations create high expectations; as a company priced for "perfection," you can't imply that your growth will dramatically slow down and expect the market not to punish you. That's why valuation is so important for investors to consider; it's the market's way of announcing its expectations for a company, and a higher valuation has less room for disappointment.
Growth outlook still looks strong
As far as Snowflake's business is concerned, 66% growth is nothing to sneeze at; investors should be looking at the company's long-term growth runway, which seems pretty intact. Snowflake's nearly 6,000 customers are still a tiny fraction of the millions of companies worldwide, and data is becoming an increasingly important resource for businesses.
Snowflake's consumption-based pricing is aligned perfectly with the big-picture trends in the data industry. People are generating more and more data each day, including internet activity, communications, social media, and more. As our world becomes increasingly digital, companies are trying to understand this increased data production to make the best decisions. Usage-based billing can capture that growing data volume.
The world created an estimated 71 zettabytes (or 71 trillion gigabytes) of data in 2021, which could double by 2025. Snowflake's cloud-native platform to store, analyze, and exchange data could have a very long runway of sustainable double-digit growth -- which perhaps helps explain the stock's high valuation to this point.
Is Snowflake a buy?
Snowflake is a fundamentally strong company that could be an excellent long-term growth stock to own. Investors should celebrate the dip in shares and, frankly, root for more air to come out of the valuation.
Investors may want to consider a dollar-cost averaging strategy to build a position slowly over time. Nobody knows what a stock will do tomorrow or the next day, and waiting for the perfect moment could easily lead to investors missing the bottom on Snowflake's stock entirely.
