Snowflake (SNOW 1.21%) is a maker of enterprise software for storing data on the cloud, where it can then be analyzed and acted upon. The stock was down 58% in 2022, but Wall Street is getting increasingly excited about the company's prospects in 2023.
On Jan. 12, Citi analyst Tyler Radke said Snowflake was one of his top software picks for 2023, according to The Fly. One week earlier, Wells Fargo analyst Michael Turrin said Snowflake stock could hit $170.
Here's a look at whether Snowflake is a good stock to buy right now.
What's happening with Snowflake
Here's the easiest way for me to highlight Snowflake's exponential revenue growth: In its fiscal 2021, the company generated $592 million in revenue for the entire year. Two years later, Snowflake expects to generate revenue of $535 million to $540 million in the fourth quarter of its fiscal 2023 alone.
SNOW revenue (TTM); data by YCharts. TTM = trailing 12 months.
When Snowflake signs customers, it usually bills them for the coming year based on how much they intend to use the platform. Customers can then use Snowflake as much as they want, based on what they've already paid for. But in some cases, they go over and are charged more based on what they've used. And then their real usage sets the terms when contracts are renewed.
This hybrid-consumption model is beneficial for Snowflake for two reasons. First, its customers only pay for what they use, which I'm sure they appreciate.
Second, Snowflake still has good revenue visibility. For example, the company has over $3 billion in remaining performance obligations as of the third quarter of its fiscal 2023, up more than 10% just from the previous quarter.
Winning customers with deep pockets is also working for Snowflake. At the end of its third quarter, the company had 7,292 total customers, up 34% from the prior-year quarter. And that included 287 customers spending at least $1 million annually, which was up a whopping 94%.
Clearly, there's a lot to like about Snowflake's business, and it's why Wall Street is getting more bullish.
Is Snowflake stock a good buy?
To be clear, Snowflake is the kind of company I believe investors should be looking to invest in. We haven't discussed all of its merits here. But the company is benefiting from a big trend in data, is growing fast, and has enviable profit margins. That can be a recipe for market-beating returns -- at the right price.
Regarding profits, Snowflake has a really good and improving free-cash-flow (FCF) margin that's expected to hit 21% in this fiscal year. Assuming the company reaches its projections, that would be more than $400 million in FCF, which is nothing to sneeze at.
Moreover, Snowflake believes it can hit $10 billion in annual revenue by calendar year 2028 and that it can improve its FCF margin to 25% by that time. This means the company is projected to generate quite a bit of cumulative FCF over the next six years.
However, the value of Snowflake's business -- its market capitalization -- is $46.5 billion, as of this writing. It trades at a very high multiple of its trailing FCF and even trades well beyond the most optimistic cumulative FCF projections for the next six years.
In my opinion, Snowflake will need to hit all of its guidance simply to justify its current price. And it would need to do substantially better than its guidance to outperform the market over the next six years.
In his 1992 letter to Berkshire Hathaway (BRK.A 0.99%) (BRK.B 0.91%) shareholders, Warren Buffett talked about the concept of margin of safety -- something he called the "cornerstone of investment success."
In short, Buffett and many successful investors calculate a stock's value based on its future cash flows. And a margin of safety is when a stock's price is far below what the investor believes the value of its future cash flows to be.
For me personally with Snowflake, I see a quality company that I love learning about. But when I try to calculate its value based on its future cash flows, I don't believe it trades at a discount. Rather, I think its price already reflects what could be an impressive multiyear run for the company. Therefore, I don't see a margin of safety with Snowflake stock.
The market is still quite optimistic about the stock. But based on what I've observed in my years of being an investor, sentiment will change at some point and Snowflake will likely eventually have that margin of safety I'm looking for. I'll be watching this company closely for that better investing opportunity.
