Data warehousing company Snowflake (SNOW 2.53%) went public in 2020, and it has been a popular holding of Warren Buffett's Berkshire Hathaway. Its fast-growing cloud-based data management and analysis business has benefited from more companies moving their operations online in order to become more flexible and efficient. But while the company has potential, there are reasons for investors to exercise caution when it comes to the stock.
Below are three charts you should look at before deciding whether to buy shares of Snowflake today.
1. Snowflake saw sharp increases in stock-based compensation
Snowflake's operating cash flow has been increasing over the years. However, stock-based compensation can skew those numbers since it gets added back into the calculation to determine operating cash flow. And stock-based compensation is dilutive to shareholders.
Image source: Company filings. Chart by author.
Its stock-based compensation of $861.5 million for fiscal 2023 (which ended Jan. 31) was more than double the $301.4 million that Snowflake reported just two years earlier. If the company had paid out those stock-based expenses out as cash, its operating cash flow for the year would have been negative. And thus, high stock-based compensation can make a company's operations look better than they truly are.
2. Snowflake's growth rate is falling
Snowflake is an appealing investment option for growth investors because its business has continued to get larger over the years. But before investors excuse the stock's high price-to-sales multiple of more than 25 for the sake of the company's growth potential, consider its declining growth rate.
Data source: Company filings. Chart by author.
For the current fiscal year, the company is projecting that its product revenue will grow at a rate of 40%, down from 70% in fiscal 2023 (which ended Jan. 31). And it's probable that in future years, the growth rate will fall further. It's easier for a company to grow by large percentages in its early years when that growth is measured against a smaller base. As Snowflake gets bigger, it will be more difficult for it to achieve a high growth rate. But what's notable is just how quickly its growth rate is declining.
If that trend continues, it'll be all the more important for Snowflake's operations to become more profitable to help justify investing in the tech stock.
3. Operating expenses remain higher than revenue
For Snowflake to become profitable, it would need to drastically bring down its operating expenses. In fiscal 2023, operating expenses were 106% of revenue. And while that percentage has been improving in recent years, there needs to be more of a decrease for the stock to be a good investment.
Image source: Company filings. Chart by author.
Slowing sales growth and high expenses are a bad combination that could result in a poor-performing stock.
Investors are better off avoiding Snowflake's stock for now
Snowflake's business is promising in that it's continuing to grow, and with a high gross profit margin of 65%, the company could attain net profitability in the future. But as of now, its financials need a bit too much improvement for it to be a good value buy.
In the past year, the share prices of Snowflake have fallen by 32%, and they could continue to decline if its financial numbers don't improve. For that reason, investors are better off waiting on the sidelines for now because while the company's business may be promising, it doesn't provide investors with good value today.
