Warren Buffett, the CEO of Berkshire Hathaway, has investments spread across a variety of industries. However, he is noticeably light in one sector in particular: software. Maybe it's because he doesn't understand the business (Buffett believes in only buying businesses you can understand), or it could be the premium price tag these stocks usually trade at. Whatever the reason, Buffett's company doesn't have many investments in this field.
However, it does have one notable one: Snowflake (SNOW 2.69%), a data cloud software provider. While Buffett usually shies away from initial public offerings (IPOs), Berkshire Hathaway got in at the pre-IPO price of $120, and the stock promptly spiked to $319 on its first trading day in September 2020. The stock has been on a roller-coaster ride since then but currently sits around $140 after falling nearly 60% this year.
Is 2023 a comeback year for Snowflake? Or is the stock at risk? Let's find out.
Snowflake's product is critical for data processing
The amount of data businesses generate today is incredible. However, storing and making sense of that data is another story entirely. That's why companies purchase Snowflake's software -- to help them store, interpret, and utilize data to drive business decisions.
Clients also appreciate how Snowflake bills them, as Snowflake only bills on a usage basis. Additionally, clients can turn the product off as necessary, especially if they only use it to run a query each quarter. When the processing side of the software is shut off, users can still store data as needed. This flexibility aligns Snowflake's interests with the user but can also subject Snowflake to revenue downturns if customers curtail their spending in response to an economic crisis.
However, that's not what customers have done so far in 2022.
Rapid revenue growth with unprofitability
In Snowflake's third quarter of fiscal year 2023 (ended Oct. 31), it generated $522 million in revenue, up 67% year over year. Much of that growth comes from existing customers expanding their usage of the product, with its net retention rate of 165%, meaning existing customers spent $165 for every $100 they spent last year.
You can see how this expansion plays out over time, as customers spending over $1 million with Snowflake annually rose 94% year over year to 287. The continuous growth of this metric is vital, as total customers only grew 34% year over year to 7,292. Still, Snowflake has only signed 543 of the Forbes Global 2000, so there are still plenty of potential clients out there.
Revenue growth driven by customers expanding their spending is a requirement for Snowflake, as the business is unprofitable.
Snowflake lost more money than it did last year, but its profit margin is improving.
| Quarter | Net Loss | Profit Margin |
|---|---|---|
| Q3 FY 2022 | $155 million | (46%) |
| Q3 FY 2023 | $201 million | (36%) |
Data source: Snowflake.
That's a significant gap to bridge; there's no doubt about that. However, the profit margin is trending in the right direction. Investors will need to see this improvement continue as Snowflake grows, as the stock is already richly valued.
A much cheaper stock valuation
Snowflake started the year at an absurdly high valuation, but it has since come down.
SNOW PS Ratio data by YCharts
Twenty-four times sales is still quite pricey, but it's a vast improvement. If Snowflake can continue growing revenue rapidly, it will also grow into this valuation. Analysts expect 46.8% revenue growth during fiscal 2024 (ending Jan. 31, 2024) to a total of $3.05 billion. That means the stock trades for around 15 times next year's sales; pricey, but closer to where many mature software stocks trade now.
As long as Snowflake maintains a rapid growth pace, investors will likely give it a premium valuation. With the stock now in a somewhat reasonable valuation range, it wouldn't surprise me if 2023 is a strong year for Snowflake stock. However, investors must watch the earnings metrics, as Snowflake can't afford to get any more unprofitable than it already is. Still, I'm a buyer of Snowflake stock, and I think 2023 will be a good year for it.
