Snowflake (SNOW -2.24%) and Zscaler (ZS -3.02%) both skyrocketed to their all-time highs last November. But after hitting those frothy levels, Snowflake's stock tumbled almost 70% as Zscaler's stock fell nearly 60%.
Snowflake and Zscaler were both crushed as rising interest rates drove investors away from pricier growth stocks. Which of these looks like the better buy now?
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What do Snowflake and Zscaler do?
Snowflake and Zscaler both provide cloud-based services. Snowflake breaks down silos across an organization by collecting data from various computing platforms and software services. It aggregates that data in a centralized data warehousing platform, where it can be easily accessed by third-party apps and data visualization services.
Zscaler provides cloud-based "zero trust" cybersecurity services, which treat everyone -- including an organization's most trusted employees -- as potential threats. Its cloud-native approach, which doesn't require any on-site appliances, is easier to scale as an organization expands.
Which company is growing faster?
Snowflake's revenue soared 124% in fiscal 2021, which ended in January 2021, and rose 106% to $1.22 billion in fiscal 2022. It expects its product revenue, which accounts for most of its top line, to grow 65% to 67% in the current fiscal year. Analysts expect its full-year revenue to rise 67% to $2.03 billion.
Snowflake serves just over a quarter of the Global 2000 list of companies. Its net revenue retention rate has exceeded 170% over the past three quarters, but it expects that to drop back to about 130% to 150% over the long term. Nevertheless, its remaining performance obligations still increased 82% year over year to $2.6 billion in its latest quarter.
Zscaler's revenue rose 42% in fiscal 2020, which ended in July of 2020, and grew 56% to $673 million in fiscal 2021. It expects its revenue to increase about 60% to $1.08 billion in the current fiscal year.
Zscaler still has a long runway for growth, even though it already serves about 40% of the Fortune 500 and 30% of the Global 2000. In the third quarter of 2022, its future revenue commitments had surpassed $2 billion -- more than double its total revenue over the past 12 months, and its deferred revenue increased 65% year over year to $819 million.
Which company is more profitable?
Snowflake's adjusted product gross margins have consistently stayed above 70% ever since its IPO in 2020. It remains unprofitable by both non-GAAP and GAAP (adjusted and not adjusted generally accepted accounting principles) measures, but it expects its non-GAAP operating margin to turn barely positive (1% at the midpoint) in fiscal 2023.
However, the company will likely remain deeply unprofitable by GAAP measures, since it spent a whopping 41% of its revenue on stock-based compensation (SBC) expenses in its latest quarter.
Zscaler's gross margins have consistently stayed above 80% since its IPO in 2018. Its adjusted operating margins also turned positive in fiscal 2019 and expanded to double-digit levels throughout fiscal 2021 and 2022.
As a result, Zscaler's adjusted earnings per share increased 73% in fiscal 2021, and it expects 24% growth in fiscal 2022. But like Snowflake, Zscaler remains unprofitable on a GAAP basis -- partly due to the SBC expenses, which gobbled up 38% of its revenue in the first nine months of fiscal 2022 -- and its net losses continue to widen.
Which growth stock is more undervalued?
Snowflake and Zscaler both trade at about 20 times this year's estimated sales. Those price-to-sales ratios are frothy in a market that seems allergic to growth stocks, but I believe Zscaler might have an easier time growing into its valuation than Snowflake for three simple reasons.
First, Zscaler's growth rates seem more stable than Snowflake's. Second, Zscaler has carved out a defensible niche in the crowded cybersecurity market -- but Snowflake still faces plenty of competitors in the cloud-based data warehousing market. Lastly, Zscaler operates at higher gross margins and generates much higher non-GAAP profits than Snowflake.
