Shares of cloud computing company Snowflake (SNOW -1.00%) have taken a turn for the worse, falling nearly 49% since the beginning of the year. This has been the general pattern of high-growth technology stocks as they face an immense pressure from inflation and the Federal Reserve's combative interest rate hikes.
Snowflake, which enables data storage, processing, and analytic solutions, is uniquely positioned in the data warehousing market, boasting a 19.3% share of the industry today, according to data from Slintel.
Worth $4.7 billion in 2021, the cloud data warehousing market is forecast to rise at a compound annual growth rate (CAGR) of 22.3% through 2026, up to $12.9 billion. Per company estimates, its total addressable market across all business areas -- such as data warehousing, data lake, cybersecurity, data engineering, etc. -- equals $248 billion. Mindful of that, it's apparent that Snowflake enjoys a long runway for growth in the years to follow. So, have short-term headwinds caused investors to lose sight of the company's long-term trajectory? Is now a prime moment to purchase shares? Let's take a look at the cloud company's current situation to determine if it's a sensible buy right now.
Image source: Getty Images.
Snowflake's business continues to make headway
The company delivered a solid second-quarter earnings report in late August, causing a short-lived spike in its share price. Its total revenue increased 82.7% year over year to $497.2 million, and it generated a net loss of $222.8 million, equal to negative $0.70 per share. The company's total customers rose 36.3% to 6,808, and its customers contributing $1 million or more to revenue skyrocketed 112% to 246. And it's obvious that its customers are satisfied -- Snowflake's net revenue retention rate has ranged between 169% and 175% over the past five quarters. A good revenue retention rate is typically 100% or above, so in this case, the company is way ahead of the curve.
This year, Wall Street analysts forecast the company's total revenue to surge 67.4% to $2.04 billion and its adjusted earnings per share to finish at $0.16, a notable uptick from its $0.01 last year. Next year, analysts expect its top line to expand another 51.6% to $3.10 billion and its earnings per share to rise to $0.46. Keep in mind that those earnings per share forecasts are adjusted, or non-GAAP, estimates. On a generally accepted accounting principles (GAAP) basis, Snowflake remains widely unprofitable, which makes it a risky investment moving forward. As of the six months ended July 31, the company has suffered a GAAP net loss of $388.6 million. As competition from well-funded tech giants like Alphabet and Amazon intensifies, there's no guarantee that Snowflake will ever operate a consistently profitable business.
Despite its ongoing selloff, the stock still pegs a price-to-sales multiple of about 32.3. That's an expensive price tag to pay for an unprofitable business that is expected to unwind top-line growth over the next couple of years. But is Snowflake undervalued when looking ahead? Let's assume that the company can generate $6.6 billion in annual sales by its fiscal 2026 year, which implies a CAGR of roughly 40% from fiscal 2022. At that time, it's unlikely that it will maintain such a lofty price-to-sales multiple as growth decelerates from existing levels. If we cut its current multiple in half to 16 -- assuming $6.6 billion in sales -- the company's market capitalization would eclipse $105 billion by its fiscal 2026 year, representing a 93% upside from today's market cap of $54.3 billion.
Should investors buy Snowflake stock?
Investors must consider two key components before investing in Snowflake stock today: its unprofitability and elevated valuation. These two elements surely make the company a risky investment, especially in today's market environment. That said, the company continues to expand its top line at an impressive clip, and its long-term growth picture is promising. If I had to place my chips on one side, I'd bet that Snowflake ends up as a secular winner down the road. I think the company will eventually achieve profitability and grow into its towering valuation. And after its recent pullback, today may be a good entry point for patient, long-term investors.
