Snowflake (SNOW 0.11%) was founded in 2012, and its short history is jam-packed with innovation. The company reshapes the way businesses use data and develop applications, and it's currently breaking new ground in the artificial intelligence (AI) arena. Snowflake stock went public in 2020 with an impressive list of investors, including Berkshire Hathaway, the conglomerate run by Warren Buffett.
But share prices have declined 61% since hitting their all-time high in late 2021, and they might still be expensive based on at least one traditional valuation metric. Investors seem to be concerned about slowing revenue growth, which could get worse given management just reduced its guidance for the full fiscal 2024 year (ending Jan. 31, 2024).
Could this be a buying opportunity for investors?
Snowflake is preparing for an AI-driven world
Large providers of cloud services like Amazon (AMZN -0.63%) Web Services and Microsoft (MSFT -0.28%) Azure have aggressively pursued artificial intelligence projects this year. The technology is maturing to the point where normal businesses can benefit from it in their day-to-day operations, and it's key for Snowflake to be involved.
Snowflake's specialty is breaking down data silos; in an increasingly cloud-based world, companies find themselves with data stored in different places, meaning they have to analyze it in isolation. Snowflake's Data Cloud platform can unify that information for customers and analyze it at scale, enabling them to draw more useful insights than ever before. The company's Snowpark platform serves a similar purpose for software developers, allowing them to build products and keep data in one place, no matter the programming language.
Now, Snowflake wants to make it easier for all employees within an organization to benefit from advanced data analysis. It intends to acquire a small company called Neeva, which has developed a unique search technology powered by AI language models. Programmers will be able to build conversational experiences using Neeva, which will allow non-technical employees to simply use search prompts to find the information they're looking for.
More than 1,500 customers used Snowflake's tools to manage a data science, machine learning, or AI workload in the first quarter of fiscal 2024 (ended April 30), which was a 91% increase compared to the year-ago period. Demand is clearly growing for AI within the Snowflake ecosystem, so the company could unlock new revenue streams by meeting customers' needs.
Snowflake's rapid growth is returning to Earth
There are a few reasons Snowflake stock has declined 61% from its all-time high.
First, the company struggled to maintain its lightning-fast revenue growth rates. In the first quarter of fiscal 2024, its revenue came in at $624 million, which was a 48% year-over-year increase. The broader economy is going through a difficult period right now, but that's much slower than the 85% growth rate it achieved in Q1 of last year.
Revenue growth for the second quarter of fiscal 2024 is expected to slow even further to just 34%. As a result, Snowflake reduced its full-year guidance to $2.6 billion (from $2.7 billion previously).
Similarly, the company's net revenue retention rate is also in decline. It came in at 151% in Q1, which implies existing customers are spending 51% more money each year. To be clear, 151% is still higher than what the majority of other software companies manage, but the figure's downward trajectory might be making investors a little nervous.
Data source: Snowflake.
Slowing growth directly impacts Snowflake's valuation
When a company is nearly doubling its revenue each quarter, investors are often willing to pay a premium price for its stock. But when growth slows, they tend to be more cautious. That deals a double-whammy to companies in Snowflake's position -- not only is its revenue increasing at a slowing rate, but its price-to-sales (P/S) ratio is also contracting at the same time.
Snowflake's current P/S ratio is 23, which is down significantly from its peak of 101. However, 23 is still very high compared to other cloud providers. Amazon Web Services and Microsoft Azure aren't perfect comparisons because they're segments of their much larger parent companies, but Amazon stock trades at a P/S ratio of just 2, whereas Microsoft stock trades at a P/S ratio of 12.
If Snowflake is to maintain its current valuation, the company's revenue growth will need to reaccelerate. There is some good news: Snowflake continues to hire more employees each quarter, and it has added 1,751 new workers in the last 12 months. It's adding to its research and development department at a faster pace than any other area, and new products and innovations tend to drive more revenue in the long term.
I've previously been bullish on Snowflake stock, but given the reduction in the company's fiscal 2024 guidance, investors might want to avoid it in the short term. It's unclear how much further its revenue growth rate will shrink, so paying such a high P/S ratio for the stock just isn't an attractive deal right now.
