When investors think of stocks Warren Buffett's Berkshire Hathaway (BRK.A -0.30%) (BRK.B -0.26%) owns, they probably think of value-focused investing. For the most part, they'd be right. Berkshire's top holdings are Apple (39%, a value play in 2016 when he first bought the stock), Bank of America (11%), Chevron (8%), and American Express (7%). However, there's at least one stock in the Berkshire that doesn't fall under this umbrella and it excites me the most.
Snowflake (SNOW -1.61%) is a fast-growing tech company that Berkshire Hathaway purchased as pre-IPO shares. Even though the investment only makes up 0.2% of Berkshire's portfolio, Berkshire still has a nearly 2% stake in the company. Why would Buffett take a position in Snowflake when it doesn't fit his investing style? Just like me, Buffett sees vast potential in Snowflake.
Image source: The Motley Fool.
Snowflake's product is beloved by its customers
Snowflake is a data cloud company that allows its customers to harness the power of the data that businesses generate. It offers solutions to store the data, process it, and utilize the information to drive modeling and other applications. Because Snowflake is platform agnostic, customers can utilize any major cloud computing providers (Amazon's AWS, Alphabet's Google Cloud, Microsoft's Azure, and others), allowing them to spread data over multiple platforms. This diversification prevents clients from being locked into unreasonable contracts and allows customers to utilize each cloud platform's strong points.
Another attractive feature of Snowflake is its pay-as-you-go pricing. Customers can turn off Snowflake's computational power at will and pay for the exact amount of data storage they need. Of course, this model has its risks, as an economic downturn may cause clients to reduce their spending. However, with how engrained Snowflake's platform is in harvesting and processing data, many users are locked into using Snowflake in good times and bad.
Furthermore, customers love Snowflake. It reported a 100% Dresner customer satisfaction score for the fifth-straight year and sported a net promoter score (NPS) of 68 (for reference, Apple's is 54). The NPS measures how much a company is promoted by its customers by surveying 100 customers on a 0 to 10 scale. On the scale are three categories of people: promoters (score 9-10, +1 to NPS), passives (score 7-8, 0 to NPS), and detractors (score 0-6, -1 NPS). The scores are added to find the final NPS. Anything over 50 is excellent, and 80 is world-class.
With Snowflake's score of 68, it's clear its customers are active promoters. But while the company provides a fantastic and necessary product, how are the financials?
Strong growth but weak profitability
Snowflake's growth is nothing short of impressive. For the first quarter of the fiscal year 2023 (ended April 30, 2022), quarterly revenue was up 84% year over year to $394 million with a gross margin of 72%. Because of its usage-based model, Snowflake's retention rate was an incredible 174%, which means customers spent $1.74 for every $1 spent in last year's quarter.
Another exciting development for Snowflake is its large customers (that spend more than $1 million annually with Snowflake), which rose 98% year over year to 206. Snowflake's total customers also grew 40% year over year to 6,322. However, it still has a large market to penetrate, as only 506 of the Forbes Global 2000 are Snowflake customers.
Snowflake has one thorn in its side: unprofitability. Snowflake's operating margin was an abysmal negative 45%. If stock-based compensation is backed out, Snowflake is barely profitable.
Investors shouldn't overlook Snowflake's heavy stock-based compensation bill because the share count rose nearly 8% year over year. This rise dilutes shareholders in a similar manner that inflation affects consumers. However, stock-based compensation is a non-cash expense, meaning the business is free cash flow (FCF) positive.
Sporting an impressive 41% FCF margin means Snowflake turned 41% of revenue into cash on the balance sheet during the quarter. This transformation is vital when heading into a potential recession, as Snowflake can survive without external funding.
Image source: Getty Images.
Like other tech stocks, Snowflake's stock valuation has come tumbling down over the past few months. Once north of 100 times sales (it's hard to justify a valuation that high for any company), it now trades for around 27 times sales. While this isn't cheap, it's not a terrible price for a rapidly growing FCF-positive company.
Despite the stock's near 70% price tumble from its all-time high, Buffett is still invested in this revolutionary tech company. While he hasn't added to his position, it wouldn't surprise me if Berkshire makes a small addition sometime soon. If Snowflake can control its stock-based compensation and work toward profitability, this stock could provide outstanding performance in a portfolio over the next decade.
