Technology stocks showed impressive momentum in the market this year thanks to the artificial intelligence (AI) hype, which explains the solid 29% gain in the Nasdaq Composite so far in 2023.
However, not all companies benefited from the surge in tech stocks. Cloud-based data platform provider Snowflake (SNOW 0.98%) got bogged down by slowing near-term growth on account of weakness in customer spending. The company slashed its guidance for fiscal 2024 when it released its first-quarter results last month (for the three months ended April 30, 2023).
Investors panicked and sold Snowflake shares in droves. This explains why this cloud stock delivered a relatively weaker return of 23% year to date as compared to the Nasdaq. However, investors looking for a growth stock may be tempted to take advantage of Snowflake's underperformance so far in 2023. Let's see why and offer up one reason to buy and one reason to sell Snowflake stock.
Snowflake could step on the gas thanks to this emerging catalyst
Snowflake's product revenue was up 50% year over year in the first quarter of fiscal 2024 to $590 million. However, the company's full-year product revenue growth forecast of 34% to $2.6 billion suggests that it is unlikely to maintain that momentum. Snowflake blames this slowdown on "an unsettled demand environment" that has caused its customers to rein in their spending.
Still, it cannot be denied that Snowflake's guidance is solid despite the near-term slowdown in customer spending. More importantly, investors should not rule out the possibility of an improvement in the company's growth as the year progresses thanks to a new catalyst in the form of generative AI.
That's because generative AI applications such as chatbots rely on massive amounts of data to respond to users' queries. Snowflake is known for providing a data cloud platform that allows customers to consolidate different data types -- structured, unstructured, semi-structured, and streaming -- using its data warehouse and data lake solutions. Customers can then derive various outcomes using the data they store on Snowflake's platform, such as making predictions, generating insights, or monetizing the data.
Not surprisingly, customers looking to deploy generative AI applications are increasingly turning toward Snowflake's offerings. According to CEO Frank Slootman on the company's May earnings conference call: "Data science, machine learning, and AI use cases on Snowflake are growing every day. In Q1, more than 1,500 customers leveraged Snowflake for one of these workloads, up 91% year over year."
The business is now looking to get deeper into the generative AI space with the acquisition of Neeva, a search technology specialist, last month. Snowflake will integrate Neeva's generative AI-powered search technology into its data cloud platform, enabling users to quickly access the data or insight they need in a conversational manner. The company points out that "Neeva will increase our opportunity to allow nontechnical users to extract value from their data."
What's more, Snowflake is now partnering with AI pioneer Nvidia to help businesses create custom generative AI models. More specifically, enterprises will be able to create custom large language models (LLMs) within the Snowflake Data Cloud using Nvidia's NeMo platform, which allows companies to take advantage of the chipmaker's graphics processing units (GPUs) to accelerate AI workloads.
With Snowflake already sitting on a total addressable market (TAM) worth $248 billion, the integration of AI into its offerings could help the company dig into this massive opportunity at a quicker pace and maintain solid levels of revenue growth in the long run.
SNOW Revenue Estimates for Current Fiscal Year data by YCharts
The company believes that it is on track to hit $10 billion in product revenue in fiscal 2029, which would be a 5x jump in six years as compared to the $1.94 billion in product revenue it generated in fiscal 2023 (which ended on Jan. 31, 2023). So the future seems bright for Snowflake, and it looks like an ideal pick for growth investors looking to buy a cloud stock for long-term gains.
A hefty valuation may tempt investors to hit the sell button
However, there is one thing that could weigh on Snowflake stock and could entice investors to sell it following its 2023 gains.
We have already seen that Snowflake is forecasting a near-term slowdown in its business, and that could very well be the reason why investors may be wanting to sell the stock now since it is very expensive. Snowflake trades at a whopping 25 times sales. That is significantly higher than the S&P 500's price-to-sales multiple of 2.5.
It is difficult to justify that rich multiple given the company is projecting just 34% growth in product revenue this fiscal year following a 70% jump in the previous one. It is also worth noting that Snowflake traded at 24 times sales at the end of 2022. In other words, Snowflake's multiple went up this year following its rally even though its growth is expected to decelerate remarkably.
So cautious investors may want to book their profits and exit Snowflake on account of its expensive sales multiple and weaker growth forecast for the current fiscal year. But then, they should also remember that Snowflake is seeing strong AI-related demand, which could result stronger-than-expected growth. Therefore, investors who already hold Snowflake stock may want to continue holding it in their portfolios because there is a strong chance of this cloud play delivering more upside.
