What happened
Shares of data company Snowflake (SNOW -1.33%) fell 5.7% in October, according to data provided by S&P Global Market Intelligence. Normally a move this small isn't noteworthy. However, it's more significant when compared to the 8% gain for the S&P 500 during the month. Here's why the market seems less bullish on Snowflake stock right now.
So what
To frame the narrative, Snowflake stock is priced with high assumptions of growth -- assumptions that may be getting questioned. Regarding its valuation, the stock traded at around 100 times sales this time last year. The valuation has since dropped because of market conditions. However, its current price-to-sales ratio of 25 is still high.
Snowflake's long-term growth forecast has made some investors believe this premium valuation is warranted. The company is guiding for $10 billion in annual revenue by its fiscal 2029 (which mostly overlaps with calendar 2028) with a top-tier free-cash-flow (FCF) margin of 25%, up from trailing-12-month revenue of $1.6 billion and a FCF margin of 11% in the most recent quarter. And it plans to achieve these long-term numbers by acquiring new customers and from existing customers increasing their spend with higher platform usage.
Therein lies the problem: The market is starting to question the cloud, enterprise-software space. For example, Piper Sandler analyst Brent Bracelin lowered his price target for Snowflake stock on Oct. 20, according to The Fly, citing "near-term risks" in this market.
Indeed, Snowflake stock fell with Amazon stock late in the month. Sales for Amazon Web Services (AWS) -- one of the biggest cloud operations in the world and a Snowflake partner -- is slowing down. In the third quarter of 2022, sales for AWS were up 27% year over year, compared to 39% growth in the prior-year quarter.
Slowing growth from this cloud titan wasn't encouraging for Snowflake investors. And the stock has continued falling in the first few days of November. Consider that large-cap enterprise software company Atlassian noted that its customers aren't growing their workforces, which is challenging the company's revenue growth.
The same dynamic could impact Snowflake's business in the near term. The company has a usage-based business model, benefiting from higher activity. And if its customers are slowing down, there's a good chance activity is decreasing. These factors were likely weighing on investors' minds in October.
Now what
Snowflake is expected to report financial results for the third quarter of its fiscal 2023 on Nov. 30. Management is guiding for 60% to 62% year-over-year growth for product revenue. And as we've seen, this kind of growth won't come easy. If it hits or exceeds its guidance, that would be an excellent sign for the resilience of this business.
One final thing to watch is Snowflake's cash position. The company had roughly $5 billion as of last quarter. While not core to its business operations, it's possible that money is generating substantial interest income, what with rates spiking higher over the past year. This could provide a nice cheery on top of its quarterly results.
