What happened
Shares of Snowflake (SNOW 2.53%) plunged 25.5% in May, according to data from S&P Global Market Intelligence. The plunge was especially discouraging considering the cloud data lake provider had already fallen so much this year heading into the month. After this-month's decline, Snowflake is down 62% on the year and 67% below its all-time high.
The company reported earnings in May. While Snowflake beat expectations for revenue, it also continues to print losses, and its outlook for decelerating revenue, albeit off a very high rate, put its sky-high valuation into question.
So what
As inflation and interest rates have stormed higher since the beginning of the year, growth-tech stocks have sold off hard. Despite relatively solid financial metrics, much of the cloud software industry came into this year with nosebleed price-to-sales ratios, with no room for error. Investors are coming around to see these stocks as overvalued.
That's what's happening with Snowflake. In its fiscal first quarter, revenue zoomed 84.5% higher, ahead of analyst expectations, and impressive by just about any measure. However, net losses per share came in worse than expected, at negative $0.53.
Additionally, management guided for full-year revenue growth of just 65% to 67%, a marked deceleration from last quarter and a slight compression in adjusted (non-GAAP) gross margin, which one would normally expect to expand as the company grows. Of note, Snowflake operates on a consumption basis, not a recurring subscription, so its growth rate could decelerate if the economy does. It looks as though that's what's baked into guidance.
However, results weren't necessarily the reason Snowflake fell. Rather, investors are coming around to the realization that the stock was too expensive heading into the year, giving itself an almost insurmountable bar to clear. At the beginning of 2022, Snowflake's price-to-sales ratio was near 100. Even as sales have grown a lot over the first half of the year, the price-to-sales ratio is still nearly 28, which is expensive by historical standards, no matter how fast you're growing.
Image source: Getty Images.
Now what
Before Snowflake went public in September of 2020, it was supposed to fetch a price of $75 to $85 per share in its IPO. However, when Berkshire Hathaway disclosed it wanted to own shares of this high-growth software company on its IPO, shares wound up going public at $120 before skyrocketing more than 100% to over $250 on its first day of trading. Eventually, shares reached $405 late last year.
Even though shares are now back down to $128, that's still higher than Snowflake's already-inflated IPO price and far higher than the company's initial valuation in the $80 range. Since the company was perhaps the most-hyped software stock among many hyped-up software stocks in the 2020-2021 period, it's possible it could fall the furthest, too.
Make no mistake -- Snowflake has an awesome product that's clearly well-loved by customers. The cloud data platform is opening up many more use cases for big data analytics, allowing companies to glean more data-centric insights and increasing their competitiveness. Because it works across different clouds, Snowflake allows customers to eschew cloud "lock-in."
However, investors can't pay just any price for a business, no matter how good it is. Snowflake definitely belongs on any tech-investor's watchlist, given its competitive advantages and cutting-edge cloud tech. However, even at this beaten-down valuation, there's little room for error. While it's impossible to say when a growth stock will bottom, Snowflake still trades at over 21 times this-year's guided revenues.
Given the elevated risks in terms of interest rates and inflation, I'd personally hold out for a cheaper price, despite the huge decline stockholders have already endured.
