Snowflake (SNOW 3.69%) has had quite a year so far in 2023, propelled higher by strong results to close out last year and a broader recovery by technology stocks. Share prices of the cloud-based data specialist are up 24% so far this year, more than 2-1/2 times the 9% gains of the S&P 500. This is in stark contrast to the stock's abysmal performance last year, when the price fell nearly 58%.
The biggest catalyst driving its market-beating gains is Snowflake's better-than-expected financial results, which suggested the start of a recovery for the software-as-a-service (SaaS) market. This gave investors confidence that the worst might be over and that the macroeconomic headwinds that buffeted the stock might finally be slowing.
What does this mean for investors who sat out Snowflake's current rally? Should they buy now in anticipation of further gains or avoid the stock due to its frothy valuation and the economic uncertainty that remains? Let's take a look.
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What's been weighing on Snowflake stock?
In the face of the challenging economy, many companies had to make difficult choices to make ends meet. Many decisions came down to what costs were mission-critical and which could be deferred.
While some businesses view cloud data storage and analysis as a necessity, others view it as a luxury that can be trimmed or cut entirely in response to difficult (though temporary) economic conditions.
This was crystal clear in Snowflake's results in fiscal 2023 (ended Jan. 31). Full-year revenue grew 54% year over year, and while that's respectable by any measure, it was markedly slower than the company's triple-digit gains in 2021. It was also quite a bit below management's initial full-year guidance, which called for growth of 66%.
Yet many of Snowflake's business and financial metrics continue to be enviable. The company's net revenue retention rate, which measures spending by current customers, remains high at 158%.
Furthermore, while its customer growth of 31% is impressive, it pales in comparison to the 79% growth of those spending more than $1 million on a trailing-12-month basis. Clients rave about its services, with a customer satisfaction score of 100%, according to Dresner Advisory Services.
These strong metrics suggest that just as the weak economy weighed on sales, the return of more-robust business spending could propel Snowflake to new heights.
What could drive Snowflake stock higher?
Besides the coming rebound in general business spending, there are other catalysts that could drive a Snowflake stock rally.
The accelerating adoption of artificial intelligence (AI) has made headlines lately, and while Snowflake isn't a pure-play AI company, it will no doubt benefit from the trend.
Of the companies looking to deploy AI, some will want these algorithms and models trained on proprietary data, while keeping that information away from prying eyes. That will require "cleaning and sandboxing" of data, according to Goldman Sachs analyst Brook Dane, making Snowflake an ideal beneficiary due to its data warehouse and analytics services.
There's also Snowflake's vast market opportunity. Management estimates the company's total addressable market -- not counting the recent surge in adoption of AI -- at $248 billion. While we generally take such approximations with a grain of salt, it helps illustrate the magnitude of the opportunity ahead.
How to approach Snowflake stock now
Snowflake is by no means cheap, selling for roughly 24 times trailing sales. Value investors will no doubt balk at that, but I'd suggest that's a reasonable price to pay for a company that's expected to grow sales by at least 38% in each of the next two years, while earnings per share are forecast to grow 140% over the coming year and 77% in 2024. Furthermore, analysts have frequently underestimated the demand for Snowflake's solutions, so these expectations could end up being conservative.
As outlined above, there are numerous growth drivers that could spark a rally for Snowflake in the coming months and years. Veteran investors with the temperament to withstand volatility should consider buying Snowflake or adding to a position now, particularly given the company's impressive track record and the long runway ahead.
