Up 25% This Year, Is It Too Late to Buy Snowflake Stock?

Though AI software has been around for decades, generative AI has recently captured the attention of the world. The ability to issue a command in simple text, and for software to create a response or complete a task, could be a disruptive force for many years to come -- and provide growth and increased profitability for many businesses as a result. 

Snowflake (SNOW 3.69%) stock hasn't been left out of the hype. Snowflake's data management platform is key to AI development, as well as the cloud and the future of IT at large. Shares have rallied 25% so far in 2023, though they remain down 60% from their unsustainable highs of late 2021. Is it too late to buy the data cloud stock?  

A soft patch in growth is coming, AI boom or not

Snowflake got its fiscal 2024 (the 12 months ending Jan. 31, 2024) started on the right foot. Product revenue, which excludes the small but variable professional services sales segment, handily beat expectations with 50% year-over-year growth to $590 million in the fiscal first quarter.

However, as other cloud-based companies have been noting, customers are tapping the brakes right now and scrimping on IT spend. The worry is a recession in 2023, or at the very least rapidly slowing economic growth. Echoing similar comments from key cloud partner Amazon Web Services, Snowflake CEO Frank Slootman said this on the last earnings call:

We are, however, operating in an unsettled demand environment, and we see this reflected in consumption patterns across the board. While enthusiasm for Snowflake is high, enterprises are preoccupied with costs in response to their own uncertainties. We proactively work with customers to optimize their environments. This may well continue near term, but cycles like this eventually run their course. Our conviction in the long-term opportunity remains unchanged.  

The good news is that Snowflake expects to continue outperforming the cloud market at large this year. Product revenue is expected to increase 34% over last year to about $2.6 billion. It's a massive slowdown (product revenue increased 70% last year) but still an impressive rate of growth given that research firm Gartner expects cloud growth to increase "only" about 22% in 2023 to nearly $600 billion worldwide.

The best way to invest in Snowflake

Longer term, the intrigue surrounding AI is but one secular trend that can keep Snowflake running in high gear for many more years. Even with a more sluggish outlook, management believes Snowflake remains on track to reach $10 billion in product sales by fiscal 2029 (calendar year 2028). If the company achieves its $2.6 billion in product sales this year, it would need to average about 31% annual growth in each of the next five years.

For the record, if Snowflake is successful, it would become one of the fastest-growing enterprise software companies ever to reach that $10 billion milestone. And with the stock trading for a very high 95 times trailing-12-month free cash flow, suffice to say many investors are believers.  

I've remained cautious and am still on the sidelines at the moment. There have been plenty of deals out there after the bear market of 2022, which is why I haven't allocated money to Snowflake yet. But is now the time to go shopping? I think the answer is still "maybe."

The company has done a tremendous job growing its free cash flow per share in the last year (it's doubled over the last reported 12 months), and management has even allocated some of that free cash flow to share repurchases to help offset the dilutive effects of employee stock-based compensation. It repurchased nearly $192 million in stock in fiscal Q1, nearly offsetting the $265 million worth of new stock given to employees.

But is the stock a buy now? To arrive at a fair value on the current stock price of nearly $190 using a discounted cash flow model, the market seems to be assuming about 30% free-cash-flow-per-share growth over the next six years (through calendar year 2028), and then 8% growth thereafter.

It will be a tall order to accomplish this feat, but so far, Snowflake has been able to deliver. Given the elevated stock price, I still think this is a prime dollar-cost average stock candidate. That assumes an investor has the money to allocate to Snowflake on a regular basis (monthly or quarterly), can stomach some wild swings in stock price, and has additional money to diversify their portfolio with other stocks. 

It certainly may not be too late to buy Snowflake stock, but I believe prudence is still the best way to go with this one.