Although Snowflake (SNOW -1.10%) is one of the fastest-growing companies in the market, it's also unprofitable -- a bad trait to have in this turbulent economy. Unfortunately, rising interest rates are like kryptonite to high-growth, unprofitable stocks. And once the market anticipated the Federal Reserve would raise interest rates, unprofitable cloud stocks like Snowflake dropped like a rock.
But despite the poor stock performance in the short term, this company's long-term performance depends on other factors. Here's one trend that should drive Snowflake's long-term results.
The predictive power of data is revolutionary
Technological improvements in artificial intelligence and cloud computing have recently made it possible to use the vast volumes of information that companies collect to make critical decisions about the future -- a revolutionary development. As a result, more and more companies are becoming data-driven, using data to make a wide variety of business decisions, rapidly changing the way executives and managers, who use intuition, gut feelings, or anecdotal information to make these decisions, operate.
Many organizations have observed flaws in these old ways of making business decisions during the pandemic. For instance, during a recent Goldman Sachs conference, Snowflake CEO Frank Slootman gave an example of how large retailers operating without data-derived insights sent the wrong products to the wrong stores. This mistake occurred because management, using an unscientific decision-making process, could not anticipate people changing their shopping patterns in response to inflation.
Pre-pandemic, many companies delayed establishing data-driven decision-making strategies. However, over the last few years, COVID-19 has accelerated organizations' need to adopt these strategies. According to a 2021 survey by management consulting company NewVantage Partners, "99% of firms have invested in data initiatives, and 92% reported the pace of investment is accelerating."
Guess who benefits from this trend of increasing adoption of a data-driven approach? If you guessed Snowflake, you'd be correct.
The platform helps firms gain the best insights from data
Snowflake's founding vision was to remove all barriers preventing organizations from acquiring the best insights from all available data. The company accomplishes this barrier removal in two ways.
First, data sharing is essential for organizations to gain accurate predictive insights. According to consulting giant Gartner, "Data and analytics leaders who share data externally generate three times more measurable economic benefit than those who do not."
But privacy initiatives like the European Union's General Data Protection Regulation created a giant roadblock for companies sharing data. Snowflake removes this hurdle with its "data clean rooms," which enable multiple companies or divisions within a single company to share and join data securely. This technology ensures that companies can share data without violating privacy or data governance regulations.
For instance, internet advertising company The Trade Desk has partnered with Snowflake to enable agency clients and brands to analyze ad performance information without directly exposing identifiable data on people who watch the ads. Other data-driven industries, such as healthcare and finance, have similar needs for sharing data to enable better analysis and decision-making while remaining compliant with industry regulations.
Image source: Snowflake.
Second, Snowflake was the first in its industry to create a data marketplace to enable buying, selling or sharing of live data between enterprises. Organizations that join the marketplace have access to various data, data services, and applications, including public health and financial data, identity resolution services, and software-as-a-service connectors.
The company's data marketplace opportunity is booming. Last month it reported results for the fiscal second quarter of 2023, which ended July 31, 2022. Stable edges, defined as continuous data-sharing connections between two or more Snowflake accounts, had grown 112% year over year. Additionally, 21% of its customer base had at least one stable edge, increasing from 15% a year earlier..
If you were an investor in this company, you'd want to see stable edges continue to snowball each quarter. That's because once marketplace participants establish long-term data-sharing relationships, it becomes much more challenging for them to leave the data platform -- a network-effect competitive advantage for Snowflake.
A recession could harm its stock price in the short term
It is hard to believe that this stock once sold at an eye-popping price-to-sales (P/S) ratio of 171 in 2020. Although its valuation has dropped significantly to a P/S of 33, the valuation is still extreme when compared to the computer processing and cloud services industry's average P/S of just over 4. Additionally, while Snowflake continued to show rapid year-over-year growth of 83% in product revenue in its most recent quarter, its growth is decelerating. As a result, this stock is susceptible to significant declines if Snowflake's growth deteriorates more than the market expects amid a worsening economy.
However, if you're a long-term investor, there are few better growth stocks to put your money into over the next three to five years.
