Snowflake's (SNOW 3.69%) stock has the honor of going public at one of the most absurd valuations of all time: 150 times sales. Still, many investors (including Warren Buffett's Berkshire Hathaway) paid a high price for this stock and are now underwater since its initial public offering in late 2020.
So is now a good time to get into the stock? Or should you pass? Let's find out.
Snowflake's product helps customers capture and utilize data
You may have heard the phrase "Data is the new oil." While you could argue that statement until your face turns blue, the reality is data has become vital in today's business practices. Businesses generate mountains of data through various sources with vital customer information, execution trends, and other hidden insights someone couldn't understand by staring at the information.
Snowflake's products are an answer to utilizing data to its fullest potential. Throughout the entire data process, Snowflake is there. It can store all types of data (even unstructured), has data science and machine learning applications, and then can feed that data into various programs to drive real-time decisions.
The platform is incredibly popular, which has led to significant customer growth. In Q4 of fiscal year 2023 (ending Jan. 31, 2023), Snowflake's customers spending over $1 million grew 79% year over year, while total customers grew 31%. This considerable customer growth helped increase revenue but didn't do enough to appease investors.
The stock is too expensive for the growth it's putting up
In Q4, Snowflake's product revenue grew 54%. Management also guided for 40% growth in FY 2024, which seems like strong guidance considering our economic environment.
However, with the stock trading at 22 times sales and 16 times forward sales (which utilizes 2024 projections), it remains pricey.
SNOW PS Ratio data by YCharts
Why is this a big deal? If you could snap your fingers and Snowflake was instantly profitable, it would still be an extremely expensive stock.
Using Snowflake's long-term operating model as a guide, the company thinks it can post 20% non-GAAP operating margins by 2030. This metric doesn't include essential factors like stock-based compensation, but let's forget about that for a second.
Multiplying Snowflake's $1.94 billion FY 2023 revenue by its target operating margin would yield $388 million in operating profits. With a 20% tax rate on those profits, this number falls to $310 million in net income. Dividing its market cap by hypothetical earnings yields a price-to-earnings ratio of 148.
Now, 22 times sales doesn't appear that cheap after all. Even utilizing 2024 projections would yield a forward P/E of 106.
That's the problem with highly valued companies -- they must grow rapidly for the valuation to make sense. With Snowflake's revenue growth rate slowing from 70% in FY 2023 to a projected 40% growth in FY 2024, the stock could be in trouble, as the stock price may fall to compensate for the lower growth.
Furthermore, my instant profit assumption is flawed, as Snowflake lost $207 million in Q4 compared to $589 million in revenue, a 35% loss margin. The biggest factor? Stock-based compensation. In Q4 alone, Snowflake handed out $256 million in stock to its employees, up 53% over FY 2022's Q4. With this metric increasing nearly as fast as revenue, it's a concern, as Snowflake should be working toward profitability, not getting further away.
I'm a massive believer in Snowflake's product and future growth. However, the stock is incredibly expensive, and its profitability metrics are trending in the wrong direction. I will continue to hold my Snowflake shares, but I won't add unless the company becomes more efficient or grows faster.
