2022 has been a whirlwind for technology stocks. All year long, investors have listened to management teams discuss supply chain hiccups, chip shortages, labor constraints, and inflation.
All of these market variables represent unique challenges that need to be navigated. And during times of pronounced market volatility, it's not uncommon for some investors to sit on the sidelines to accumulate cash.
While we're not out of the woods yet, some stocks do appear to be good buys at current valuations. Below, you'll see why this may be an opportune time to scoop up some shares of data-giant Snowflake (SNOW 2.49%).
Financial results
For its second quarter of fiscal 2023, ending July 31, 2022, Snowflake reported $497 million in revenue, up 83% year over year. Snowflake's revenue stems from two primary sources -- products and services. Product revenue represents its software platform, which typically carries higher margins. By comparison, professional services are typically lower-margin, non-recurring revenue. For the quarter that ended July 31, 2022, Snowflake generated $466 million in product revenue, up 83% from the same period in the prior year.
When we analyze the key performance indicators of Snowflake, the company's high double-digit revenue growth shouldn't come as a surprise. For instance, Snowflake's net retention rate as of July 31, 2022, was 171%, up from 169% during Q2 of fiscal 2022.
Net retention is an important metric for software businesses because it measures annual recurring revenue streams, net of customer churn. Since this ratio is above 100%, this implies that Snowflake is far outselling any churn the company experiences.
Another crucial metric that Snowflake discloses is remaining performance obligations (RPO), which measures the dollar amount that's signed but not yet paid by customers. In other words, RPOs contractually owe money to Snowflake at a future date. As of July 31, 2022, the company's RPOs were $2.7 billion, representing 78% year-over-year growth.
Investors should be highly encouraged that Snowflake is demonstrating such robust growth from its software platform. Moreover, given the high visibility into future revenue growth, coupled with strong retention metrics, Snowflake is in a position to capitalize on the growing market of big data.
All of these ingredients make for a great recipe to expand the margin profile of the business, achieve operating leverage, and pave a path to consistent profitability.
Image source: Getty Images.
Looking to the cloud
Technology behemoths Microsoft, Amazon, and Alphabet all have large cloud computing businesses. It's important for investors to understand that Snowflake's platform relies heavily on these cloud operators.
For example, a corporation may employ a multi-cloud strategy and have its applications running on public clouds from different providers. Snowflake's software, called a data lake, has the ability to integrate with all three of the leading cloud platforms. This is a huge competitive advantage.
During the earnings call, Snowflake CFO Mike Scarpelli stated that "the majority of our customers, 80-plus percent, run in AWS, and about 18% is Azure and 2% is GCP." This dynamic is not entirely surprising in light of each company's cloud results.
While Amazon is currently dominating the market, there's a huge opportunity for Microsoft and Alphabet. In essence, as Microsoft and Alphabet continue to grow in the cloud, demand for Snowflake, which has strong relationships with these tech giants, should increase in lockstep.
Investors could argue that as long as big tech continues growing in the cloud, Snowflake will command more business. And given the fact that these are typically high-dollar and multiyear cloud contracts, Snowflake should benefit from these factors in the form of stickier retention rates.
Valuation is key
Since debuting on the public markets exactly two years ago, Snowflake's stock has reached unparalleled highs, only to come cratering down. In 2022, Snowflake stock is down a whopping 44% at the time of writing.
Some investors could argue that Snowflake stock is overvalued. While the company is demonstrating strong top-line growth, it's not yet profitable and trades for 37 times its trailing-12-month sales. However, at the end of Q2 in fiscal 2022, Snowflake was trading for 110 times trailing-12-month sales. To put this into perspective, Snowflake's valuation has fallen by almost two-thirds over the last year.
While macroeconomic factors, such as inflation and supply chain challenges, are beyond Snowflake's control, investors can see that its cohorts, namely big-tech cloud giants, are still generating robust growth. Given Snowflake's reliance on public cloud providers, there's a solid chance that Snowflake will follow suit as Big Tech grows.
These tailwinds make Snowflake a compelling buy at its current valuation. For investors with a long-term time horizon, now is an ideal time to scoop up some shares and dollar-cost average into the existing position.
