Warren Buffett is the head of Berkshire Hathaway, which owns shares of around 49 different companies. He has steered the conglomerate to market-beating returns for more than 50 years thanks to his long-term investing strategy.
Buffett likes buying into businesses with great management teams, steady growth, and consistent profitability. It's an added bonus if the company is returning money to shareholders through dividends and stock buybacks. The investing legend usually avoids fast-growing technology companies because they don't tick all of those boxes.
Therefore, it came as a surprise when an investment manager at Berkshire (not Buffett) acquired a position in cloud computing company Snowflake (SNOW 3.69%) prior to its initial public offering in 2020. That position only accounts for 0.3% of Berkshire's $383 billion portfolio today, but Snowflake is losing money hand over fist, and it certainly isn't paying a dividend.
The company's growth has also slowed dramatically in recent quarters, much to the disappointment of investors. Snowflake is due to release its financial results for the fiscal 2024 second quarter later this month, and there's a chance of further disappointment.
Snowflake is pivoting toward artificial intelligence
The artificial intelligence (AI) revolution is still in its early stages, but its impact is being felt across the corporate world. Generative AI -- which is capable of creating text, images, videos, and computer code -- powers chatbots that are already transforming the way we work and access information. Snowflake is well positioned to capture some of the value creation this new industry will generate because AI is developed and deployed in the cloud.
Snowflake is a provider of cloud services. Its Data Cloud is an aggregator of information, breaking down silos for businesses that typically use multiple platforms like Microsoft Azure and Amazon Web Services. Rather than analyzing their data in isolation through each provider, they can access all of it through Snowflake where they can draw the most valuable insights.
Its Snowpark platform serves a similar purpose for software developers, who can come together in one place to build products no matter which programming language they're using. This means critical data and digital assets stay in one place, which facilitates collaboration and speeds up project completion.
Now, the company is breaking ground in the AI space. It has already acquired three companies that have created AI-powered tools centered around streamlining data analysis. For example, it purchased a start-up called Neeva which built a unique search engine powered by generative AI. It helps businesses query and discover their data in more effective ways. Snowflake also acquired Streamlit, which is a go-to platform for developers who want to create generative AI applications using large language models.
Snowflake's goal is to stand ready as the AI revolution gathers steam, so it becomes the cloud provider of choice for businesses developing the technology.
But AI hasn't stopped Snowflake's revenue growth from rapidly decelerating (yet)
When Snowflake listed on the public markets in Sept. 2020, it was coming off a fiscal 2020 year (ended Jan. 31, 2020) with just $264 million in revenue. That was a relatively low base to grow from, especially given the rapid migration to cloud services among businesses around the world.
It more than doubled that revenue figure in fiscal 2021, delivering $592 million for the year. It doubled it again in fiscal 2022, generating more than $1 billion in revenue for the first time. That became a major reason investors wanted to own Snowflake stock. The company was quickly growing into its high valuation, and its business was expanding at a faster pace than traditional cloud providers like Microsoft Azure and Amazon Web Services.
But it's unrealistic to expect any company to grow at that pace forever. The law of large numbers eventually catches up, making it harder for Snowflake to deliver the same growth rates as its revenue base gets bigger.
The company is not only grappling with that phenomenon, but it's also fighting a slowing cloud market amid this tough economic climate because businesses are investing less money in expanding their digital infrastructure. As a result, Snowflake reduced its fiscal 2024 guidance for product revenue (about 95% of the top line) during the first quarter, and it now expects annual growth of just 34%.
That outlook disappointed investors, and Snowflake stock sank 16% the day after it released that Q1 report.
The slowdown also creates a series of other challenges. First, investors will begin to temper their future growth expectations for Snowflake, which means they'll want to pay a lesser valuation for its stock (more on that in a moment). Second, the company is still losing money -- it burned $226 million on the bottom line in the first quarter alone.
Therefore, Snowflake may have to slash its expenses if revenue growth continues to slow, otherwise it will face blowout net losses in the coming quarters. But cutting costs will also impact its ability to expand its business, which could in turn lead to even slower growth.
Snowflake stock is relatively expensive
Investors typically look at a few different valuation metrics when deciding whether to invest in a stock. Since Snowflake isn't profitable, the focus is on its revenue so the price to sales (P/S) ratio is a common metric to watch. Based on the company's $2.3 billion in trailing-12-month revenue and its current market capitalization of $55.3 billion, Snowflake stock trades at a P/S ratio of just over 24.
That is extremely high. Microsoft stock, for example, trades at a P/S ratio of 11.6, and Amazon trades at a P/S ratio of just 2.5! As I mentioned earlier, investors were comfortable paying a high premium for Snowflake when it was growing its revenue at a triple-digit rate year after year, but given its slowdown, it's no surprise the stock has fallen 58% from its all-time high.
Yet despite this decline, it's still carrying such a high valuation, which means there could be more downside ahead. The trigger for a further slide might come with Snowflake's fiscal 2024 second-quarter financial results, coming on Aug. 23. If the company downgrades its full-year revenue guidance again, I'd expect a very negative reaction from investors.
Could Snowflake disappoint investors for the second time this year? It's impossible to say for sure. Berkshire Hathaway might be sitting on a small profit on its pre-IPO purchase from back in 2020, but it's unlikely the firm -- or Buffett himself -- would pay today's price given the circumstances. Other investors should follow that lead, at least until Snowflake can prove its ability to reaccelerate its revenue growth.
