Many investors believed that shares of cloud-based data company Snowflake (SNOW -1.61%) were overpriced from the moment the company went public in 2020. But while some argue that Snowflake stock is overvalued, others hold the counterargument that the company's revenue growth rate is superb, and it warrants a high valuation.
Well, Snowflake's management just lowered its revenue growth guidance and expects the company to grow at its slowest pace ever. So what now?
The problem: Growth is slowing for Snowflake
Snowflake went public when it was growing revenue at a 100%-plus annual rate. I believe all reasonable investors expected the growth rate to decline over time -- after all, management's own forecasts suggested this trend. And indeed, revenue growth has slowed for Snowflake, as the purple line on the chart shows.
SNOW Revenue (Quarterly YoY Growth) data by YCharts
The chart doesn't show what Snowflake just reported for the fiscal first quarter of 2024, which ended in April. In Q1, the company grew revenue 48% year over year to $624 million. And product revenue grew 50%. For perspective, product revenue makes up about 95% of Snowflake's total revenue.
Q1 revenue growth was clearly slower for Snowflake. And guidance for growth in the upcoming second quarter is slower still. Management expects Q2 product revenue of $600 million to $625 million, which would represent 33% to 34% year-over-year growth.
For fiscal 2024, Snowflake's management expects to generate product revenue of $2.6 billion. That's down from its previous estimate of over $2.7 billion.
The new guidance from Snowflake suggests 34% year-over-year product revenue growth for the entire year. However, management's guidance also implies about 28% to 29% year-over-year revenue growth in just the second half of fiscal 2024. In other words, revenue growth is expected to slow in Q2 and to continue slowing thereafter. And that's significant.
Why is growth slowing for Snowflake?
Here's the first reason why Snowflake's expected slower growth for the second half of fiscal 2024 is significant: Management expected growth to rebound later this year, not slow down.
Snowflake has a usage-based business model -- revenue goes up with more use. To drive usage, the company is working to make it easier to build and deploy apps that will help companies do more with their data. In November, it updated Snowpark -- a product for developers -- to integrate with a popular coding language called Python, hoping it would fuel developer activity and drive product usage.
In the fiscal fourth quarter of 2023, 20% of Snowflake's customers had tried Snowpark, and in Q1, 30% had. Snowflake's management believed that Snowpark would drive usage on the platform. Last quarter, CEO Frank Slootman said, "In terms of what we're already seeing in the velocity of consumption that is coming from Snowpark, we think it will be in the second half at some point, where we're going to see what we think is a material impact from that."
However, considering that management's guidance implies just 28% to 29% year-over-year revenue growth in the second half of the year, Snowpark isn't reaccelerating Snowflake's revenue growth rate as expected -- at least not yet.
Snowflake's management also doesn't appear to have anticipated another factor. In the Q1 conference call, CFO Mike Scarpelli said: "Some organizations have reevaluated their data retention policies to delete stale and less valuable data. This lowers their storage bill and reduces compute cost."
While a lot of enterprise data is migrating to Snowflake, it appears some customers are getting rid of outdated data. This lowers usage on the platform and is contributing to Snowflake's slowing growth.
What should investors do about Snowflake stock?
Here's the second reason the slower growth is significant: Management is guiding for $10 billion in product revenue in its fiscal 2029. This guidance implies a 31% product revenue compound annual growth rate (CAGR) over about the next six years. That's absolutely stellar growth at this scale, and it's why investors bestowed Snowflake stock with such a generous valuation.
Snowflake stock is down more than 60% from its all-time high. But it still trades above a price-to-sales (P/S) ratio of 20, which is historically an extremely high multiple to pay for a market-beating investment.
SNOW PS Ratio data by YCharts
The market is still giving Snowflake a lot of credit because of its long-term vision. And Scarpelli was clear on the conference call: Its revenue goals for fiscal 2029 haven't changed.
However, by management's own guidance for this year, Snowflake's growth rate could fall below the growth CAGR needed to hit its goals. If that happens, I would expect the market to respond negatively. And for this reason, I still see enough valuation risk with Snowflake stock to avoid it for now.
