Snowflake (SNOW 1.12%) has had a bit of a rollercoaster start to the year. It rocketed out of the gate, rising 24% by the start of February, but at this writing sits 3% down from where it entered 2023. With many other tech companies up 20% or more, investors might wonder if now is an opportune time to buy some Snowflake shares.
While the price movement may seem favorable, there are some warning signals investors need to be aware of. Let's look at what those are and see if Snowflake stock is a buy now.
Snowflake's size is slowing its growth
Snowflake's primary offering can be summed up as "the data cloud." With Snowflake's software, clients can efficiently store all types of data, then use that information to inform business decisions through data science or create a pipeline that feeds an external application.
As the business world moves to a cloud-first approach, Snowflake's software is becoming a vital piece of the infrastructure. Additionally, the product benefits its clients, so much so that the average client spent 58% more over the past year than they did one year ago.
This led to rapid growth rates, which have fallen tremendously now that Snowflake has gotten much larger (it's harder to grow as fast the bigger a company gets).
SNOW Revenue (TTM) data by YCharts
Still, a 53% revenue growth rate isn't anything to turn up your nose at. But is it enough to justify Snowflake's valuation?
The stock is absurdly valued
Snowflake has always traded at high valuation levels (even absurd levels in some cases). But that valuation has come down substantially recently.
SNOW PS Ratio data by YCharts
Regardless, 22 times sales is a lot to pay for any company, especially one that is far from turning a profit. In the fourth quarter of fiscal year 2023 (ending Jan. 31), Snowflake lost $207 million against revenue of $589 million -- a 35% loss margin. It has a long way to go before turning a profit, which may be contributing to its recent weakness.
So what's a reasonable price to pay for Snowflake's stock? I'm glad you asked.
When I think about valuation, I like to frame it as: "What if the company was profitable today?" Many unprofitable companies offer long-term targets for where they'd like to end up, and Snowflake is no exception. During its 2022 investor day, Snowflake stated that its non-GAAP operating income margin target for FY 2029 (ending January 2030) was 20%. That figure wouldn't include stock-based compensation or taxes, so we'll have to figure that into our calculation.
Using a 20% tax margin and an 8% of revenue stock-based compensation adjustment, that gives Snowflake a hypothetical 8% GAAP profit margin by 2030 (the tax and stock-based compensation margins were taken from mature software company Adobe's current margins). With Snowflake bringing in $1.35 billion in revenue during FY 2023, its hypothetical profits would be about $108 million.
This would give Snowflake a price-to-earnings (P/E) ratio of 418. Bear in mind that's with 2029 projected margins.
Even if you gave Snowflake the benefit of the doubt, provided it with a 20% profit margin, and used Snowflake's FY 2029 revenue projection of $10 billion, the stock would be trading at 22.6 times FY 2029 earnings, right now. For reference, Adobe's forward (P/E) ratio (using 2023 projections) is 24.5. So, you could buy Snowflake's stock today, watch the company exceed margin expectations, meet revenue goals, and basically have a 0% return on investment for seven years.
For me to be interested in Snowflake's stock, it would have to fall to about 10 times sales. That's over a 50% drop from today's prices, so I doubt I'll have the chance to buy Snowflake stock anytime soon.
The stock is becoming more interesting, but it's still too expensive for me right now unless Snowflake's growth rate or forward guidance change.
