The Nov. 10 consumer price index report brought the focus back to the tech sector. The Nasdaq Composite Index rallied more than 700 points that day on news that inflation had cooled slightly. That implies that the interest rate hikes that are so detrimental to tech stocks may soon end.
One of the stocks that rallied following a massive decline was Snowflake (SNOW 2.53%). Now, the question is whether this serves as the catalyst Snowflake needs to move higher or if investors should stay on the sidelines.
The Snowflake value proposition
Snowflake is the company that brought attention to the data cloud. It serves as a secure central repository for data. When companies silo data on servers, it can lead to issues with access issues and questions about which versions are correctly updated.
Snowflake gets around this problem by serving as a central repository for data where administrators can control access and track usage and changes. It holds a competitive advantage over Amazon's AWS or Microsoft's Azure in that it can function well on a variety of cloud platforms. This leaves it in a position to capitalize on rapid industry adoption.
Image source: Ponemon Institute, Thales Group, IDC, 451 Research.
Moreover, Snowflake looks like it is in its early growth stages. As of the end of the second quarter of fiscal 2022 (which ended July 31), it claimed 6,808 customers, rising 36% over the previous 12 months. Additionally, customers who spent $1 million or more over the last year grew 116% to 246.
Growth and valuation
Such growth was probably a factor in attracting pre-IPO interest from Warren Buffett's Berkshire Hathaway, and that growth continues. Snowflake brought in revenue of $920 million in the first six months of fiscal 2022. This increased by 84% compared with the same period in fiscal 2021. Also, in Q2, its net revenue retention was 171%, meaning the average existing customer spent 71% more on the platform than one year ago.
Nonetheless, profitability is nowhere in sight as operating expenses exceeded revenue, coming in at $995 million. When adding the cost of revenue and other expenses, that led to a $389 million loss in the first half of 2022.
Furthermore, it supports a price-to-sales (P/S) ratio of 30. While that is down considerably from over 180 in December 2020, it is likely not at a level where one can call Snowflake stock "cheap" by any means. Additionally, it is still risky in an environment with little tolerance for money-losing tech companies. That situation may deter investors despite a much lower stock price.
Should I consider Snowflake?
Given Snowflake's role in the data cloud, the company should beat the market long term despite its massive sales multiple. The rapid revenue growth and its competitive advantage should push Snowflake higher over time.
However, the volatility of the stock makes it unsuitable for risk-averse investors. Moreover, a one-day rally does not constitute a recovery, and more multiple compression is possible. Thus, investors should only add positions slowly, if they buy this cloud stock at all.
