Warren Buffett is known as one of history's most successful value investors. A quick survey of the Berkshire Hathaway portfolio he oversees reveals that the investment conglomerate's five largest holdings are Apple, Bank of America, Chevron, Coca-Cola, and American Express. Each of these companies is an established industry leader with a sturdy business, strong brand, and history of returning cash to shareholders through dividends. But Buffett and the analyst teams at Berkshire have also put funds into some riskier, more speculative growth stocks that have the potential to deliver explosive long-term returns.
Snowflake (SNOW -1.90%) is an innovative category leader in the cloud-based analytics software space, and its stock trades down roughly 55% across 2022 and 62% from its lifetime high at the time of writing. For risk-tolerant investors willing to embrace the potential for continued market volatility in pursuit of big gains, building a long-term position in this fast-growing software player could pay off in a big way.
Image source: The Motley Fool.
Why Snowflake is such an important service provider
Snowflake's Data Cloud provides data-warehousing and analytics tools that make it possible to combine and use data from Amazon, Microsoft, and Alphabet's otherwise siloed cloud-infrastructure services. The company also operates a marketplace platform that allows users to buy, sell, and share access to data. The data specialist is already providing services that are playing an important role in the analytics revolution, but there's a good chance that the true value of its software is just beginning to unfold.
Snowflake is aiming to make its platform a go-to choice for developing and running applications. Thanks to the built-in ability to combine and analyze information from otherwise walled-off sources, users have substantial incentives to develop heavily analytics-focused applications on Snowflake's software platform. The company ended its third quarter with 709 customers using app-based programming on its Powered By Snowflake section of the Data Cloud, up an impressive 20% on a sequential basis, and it looks as if the company is just scratching the surface of its opportunity here.
Near-term challenges and long-term opportunity
While subscription-based service has become the popular model for many cloud-software companies, Snowflake operates primarily on a consumption-based billing model. This opens the door for uneven performance during periods of economic downturn and uncertainty, but it could also continue to play in the company's favor as the business scales. Usage-based billing is attractive for organizations that are looking to test the services out and not have commitments if they need to cut back on project spending.
Thus far, the company has fared very well with this approach, and it's registering net revenue retention rates that are the envy of the broader software industry. Last quarter, the company posted net revenue retention of 165%, which means that customers already using the platform increased their spending by 65% on average. This helped Snowflake's product revenue grow 67% year over year to reach $522.8 million in Q3.
Snowflake is already seeing strong usage metrics for its core data-warehousing and analytics technologies, and it could continue to enjoy stellar growth over the long term if its platform gains favor as a hub for developing and running applications. As more Powered By Snowflake apps launch and scale, usage will expand as well, setting up a dynamic that has the potential to be very rewarding as the company grows with its customers.
Why one of Buffett's riskiest stocks can be a huge winner
Trading at roughly 23.6 times this year's expected sales, Snowflake has a highly growth-dependent valuation even after big sell-offs. That characteristic sets the stage for near-term volatility if macroeconomic turbulence continues to affect momentum for the broader stock market.
SNOW PS Ratio (Forward) data by YCharts.
On the other hand, Snowflake appears to be in the early stages of shaping service categories that will be in high demand through the next decade and beyond and to be building a moat and network effect that could make it one of the most influential players in the overall cloud software services space. With a 75% non-GAAP (adjusted) gross margin last quarter and positive free cash flow on an adjusted basis, Snowflake should be in a good position to shift into profitability and earnings growth once it pivots some of its focus away from expanding its customer base and growing revenue.
Looking farther out, for the 2030 calendar year, Snowflake is estimating that it will reach annual revenue of $10 billion and record an adjusted free cash flow margin of approximately 25% and an operating income margin of 20%. Delivering on those performance targets would be impressive, but the business could still be in relatively early growth stages at that point.
Snowflake isn't a low-risk stock, and it stands out as an unusually growth-dependent holding in the Berkshire portfolio. But it could also go on to be one of the investment conglomerate's biggest winners.
