Despite an overall positive start to the year for many technology stocks, the performance of Snowflake (SNOW -2.46%) has lagged, losing approximately 8.42%, compared with the 9.1% rise in the Technology Select Sector SPDR Fund (NYSEMKT: XLK), an index of technology stocks.
However, Snowflake has a massive opportunity ahead, as virtually every company will need the type of services Snowflake offers over the long term. Its data cloud and data marketplace are necessary for an increasingly digital economy. Consequently, all growth investors should own shares of this stock. The biggest question is whether now is a good time to buy.
Let's investigate.
Investors are worried about the demand for its services
The market is punishing this data cloud company for a reason. When analyzing this business, it's essential to remember that Snowflake uses a consumption-based pricing model; customers pay for the services they use on the platform, driving revenue growth.
One problem the company had in calendar 2022 into 2023 is that many investors detest consumption-based business models during a terrible economy where consumption slows. Most investors are also cautious of unprofitable growth stocks with decelerating revenue in a highly competitive market. As a result, the stock dropped 58% in 2022.
Investors heard several things from management during the company's fourth-quarter earnings call that only increased their anxiety. First, management indicated that small and medium-sized businesses and international customers, increasingly cautious about spending too much money during these uncertain times, have slowed their consumption.
Second, new customers are ramping up their consumption much more slowly than past early adopters, which is terrible for Snowflake. As a result, management was cautious in its revenue guidance for its fiscal first quarter of 2024, with the forecast coming in below analysts' expectations. And investors not liking the uncertainty in this challenging economy dropped the stock by 14% the day after it released earnings. However, not all is gloom and doom.
While consumption has slowed in the short term, investors must remember that customers have not ended their long-term commitment to Snowflake or decreased their spending on the platform. There are larger forces at play that keep consumption growing on the platform, albeit more slowly during this economic slowdown -- namely, the secular digital transformation trend.
It has substantial growth drivers
To succeed in a world where every organization is undergoing digital transformation, which is the process of integrating computers and other electronic devices into all areas of a business, a data cloud is needed that gives people, applications, or artificial intelligence (AI) a central location to access all of an organization's data. The era of different departments storing data in various silos isolated from the rest of an organization is over.
Snowflake solves the data silo problem by providing customers with a centralized data cloud. Its most significant long-term growth driver is that companies, governments, and other organizations must adopt a centralized cloud data storage solution to succeed. And its platform provides the best data storage solution. In addition, the company has built a fledgling public data marketplace where different organizations can share, sell, or buy data from other organizations while protecting people's privacy concerns -- a potentially huge long-term business.
As for shorter-term growth drivers, the company hopes to gain FEDRAMP High and IL5 certification shortly, which should result in material new client wins in the public sector, as these certifications are necessary for the company to handle sensitive data just below the secret classification for U.S. government agencies.
Another potential near-term growth driver is customer ramp-ups in the use of Snowpark for Python, a product released in November. Snowpark enables developers to write code in several popular computer languages and run it directly on Snowflake. It developed Snowpark for Python to ride the growth of companies using machine learning, as Python is a computer language that best serves machine learning use cases. Chief Executive Officer Frank Slootman said on the fourth-quarter earnings call that the ramping up of Python workloads should help drive consumption materially in the second half of this year.
So while everything looks gloomy today, don't be surprised if the company produces some revenue upside surprises later this year from the above opportunities.
Should you buy Snowflake stock?
Today, the market values the stock at a price-to-sales ratio of 20.30, hovering just above its all-time low of 19.16, far too low for its potential in a normalized economy. At this level, a better buying time might not come around again.
Suppose you invest in this company: You are counting on three things.
- First, as the economy improves, consumption of services on its platform should improve significantly.
- Second, the company develops a moat against the competition through the network effect gained by adding new customers and partners to its data cloud.
- Third, the services on the platform prove so sticky that the platform develops a high-switching-cost moat.
Should the company create these two moats, it would result in a rising stock price from generating excess returns on invested capital and profit, significantly boosting your portfolio's returns over the next five years.
