Snowflake (SNOW -1.61%) was one of the hottest stocks to have an initial public offering (IPO) in 2020. With the pandemic bull market in full swing, combined with Warren Buffett's Berkshire Hathaway investing in the company, there was a perfect storm of excitement for Snowflake when it went public in September 2020.
It is no surprise, then, that shares more than doubled on the first trading day. In the months that followed, the stock's price-to-sales ratio (P/S) hit close to 200. A price-to-earnings ratio (P/E) of 200 is very expensive, let alone sales, so you can understand how much demand there was for Snowflake stock around the IPO.
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But since then, investors have tempered their expectations. The stock price is down 36% this year and its P/S has gotten down to a more modest 53. With shares trading at a much cheaper price, let's see if Snowflake has what it takes to be a great hypergrowth stock and whether now could be a good time to buy shares.
What is Snowflake?
Snowflake is a cloud-based database company. Specifically, it allows companies (typically large ones) to track, analyze, and store all the data they bring in. Database companies have been around for decades, but what has made Snowflake special is that it is purpose-built for the cloud, which gives its clients a lot more flexibility with their analysis and storage.
Another key reason for Snowflake's success is that it helps clients become cloud-agnostic, which means having the ability to use any of the three giant cloud infrastructure providers -- Amazon, Microsoft, and Alphabet -- without getting locked into one vendor. Since all three of the cloud giants offer competing database services, this has given Snowflake a leg up when signing enterprise customers.
Amazon Web Services, Microsoft Azure, and Google Cloud don't necessarily mind, though, because whether someone signs up with them or Snowflake, they are still getting a cut of the money being spent on cloud computing and storage.
The cloud database market is growing quickly. The data lake industry (where all the data is stored together rather than in data silos) is one of Snowflake's key segments. In 2019, this industry was estimated to be worth $7.6 billion, and it is expected to have a 20% compound annual growth rate (CAGR) through 2027. The data warehousing industry (another key segment) was estimated to be worth $21 billion in 2019 and is expected to hit $50 billion this decade. Those are some impressive growth numbers and should provide a solid tailwind for Snowflake over the coming years.
Growth has been phenomenal
There's a reason Snowflake got such a high valuation at its IPO: Its growth numbers are phenomenal. This continued in 2021. Last fiscal year, revenue increased 106% year over year to $1.2 billion with 184 customers now contributing $1 million or more in sales. Non-GAAP gross margins came in at 75%.
But the most impressive number has been net revenue retention, which hit 178% last quarter. Net revenue retention measures revenue growth from existing customers, and a 178% number means that Snowflake would have increased revenue by around 78% even if it didn't sign any new customers over the past 12 months.
Why has net revenue retention been so strong? Because Snowflake has a consumption-based model, which means the more that customers use the platform, the more they pay. With an increasing amount of data being generated by internet-connected devices around the world, it's no wonder that giant enterprises are rapidly increasing their usage (and therefore spending) with Snowflake each year.
Combine this fantastic execution with the broad industry tailwind, and Snowflake should be able to put up rapid top-line growth for many years. It is no surprise that Snowflake's remaining performance obligations (services yet to be delivered) hit $2.65 billion last quarter, or double what they were the previous year.
But what about valuation?
Right now, Snowflake has a market cap of $67 billion, which comes down to an enterprise value of $62 billion when you take out its large cash position. Let's say the business can keep up a 50% revenue CAGR over the next five years. This would bring annual revenue to $9.1 billion in the fifth year, and bring the stock's enterprise-value-to-sales ratio (EV/S) down to 6.8 based on the current stock price.
If we assume Snowflake will have 20% profit margins, which might be conservative but still close to the average for a software-as-a-service (SaaS) stock, it will have an enterprise-value-to-earnings ratio (EV/E) of 34 five years from now. For reference, the market's average EV/E ratio is between 11 and 16.
What all these numbers mean is that even though Snowflake's stock price is down from recent highs, it still has high expectations for future growth embedded in it. If you believe the company can continue growing revenue by 50% or more per year for the foreseeable future, now could be a great time to pick up some shares. But if you have any hesitations otherwise, it is probably best to avoid this high-priced software company.
