Warren Buffett is widely considered to be one of the world's best investors. He heads the Berkshire Hathaway investment company, which has outperformed the benchmark S&P 500 for more than 50 years!
Buffett has a simple approach targeting companies with solid growth prospects and strong profitability -- and that aim to return money to shareholders through dividends and share buybacks. He's also known to stick to businesses he understands.
So when one of Buffett's deputies at Berkshire took a position in a cloud computing company called Snowflake (SNOW 3.69%) right before its initial public offering in 2020, investors were left scratching their heads. Snowflake was (and still is) unprofitable, doesn't return money to shareholders, and develops highly advanced software technologies.
The company has struggled over the last couple of years with falling growth rates, and its stock price has declined 62% from its all-time high. But based on its financial results for the fiscal 2024 second quarter (ended July 31), there's reason to believe the worst could be behind it.
Here's why investors might want to join Berkshire by owning Snowflake stock.
Image source: Getty Images.
Snowflake is in the data business, so it's an ideal AI company
Snowflake is a cloud computing company designed to help businesses draw valuable insights from the mountains of data they're generating through their online operations. In the modern economy, each time a customer interacts with a business through a digital sales channel, a valuable piece of information is generated -- but processing, analyzing, and using it to improve is a complex process.
It starts with connecting data. Snowflake's Data Cloud aggregates information from multiple sources. Large organizations are particularly likely to use more than one cloud platform, like Amazon Web Services and Microsoft Azure, so without Snowflake, they would be left piecing data together from different sources, which is less efficient.
Plus, thanks to Snowflake, developers can also collaborate on one platform to enhance data processing in any programming language. Again, this means data is stored securely in one place, and it can speed up project completion.
But Snowflake is very much building for a new era centered around artificial intelligence (AI). Because it's the place where so many organizations process their data -- including 639 of the Forbes Global 2000 companies -- Snowflake is an obvious home for AI products and services.
It just opened a private beta for a new tool called Document AI, which is powered by generative AI and large language models (LLMs). It will allow customers to ask questions of unstructured data in a legal contract or invoice, for example, to rapidly speed up analytics.
Snowflake has also acquired smaller AI companies like Neeva, a search-based tool that customers can now use to engage with their data using natural language. That means even nontechnical employees within a company can extract value from their data, which significantly increases the addressable opportunity for Snowflake.
Growth is still slowing, but there are positive signs
Snowflake stock has traded in the red this year on a couple of occasions, despite a surging rally in the Nasdaq-100 technology index. This is because the company's revenue growth has slowed considerably from a couple of years ago, when it was increasing by triple-digit percentages each quarter.
The difficult economic environment at present is one contributing factor, but Snowflake's business is also maturing. As it generates more revenue, it will become harder to grow as quickly.
But in the first quarter of fiscal 2024 (ended April 30), investors were left especially disappointed because Snowflake reduced its full-year revenue forecast to $2.6 billion, from $2.7 billion previously.
Thankfully, in Q2, the company didn't reduce that forecast any further. In fact, its quarterly product revenue of $640 million was comfortably higher than its prior guidance of $625 million, and it marked a 37% increase year over year. That was still a slowdown compared to the 83% growth it delivered in the year-ago quarter, but I want to key in on three bright spots:
- First, the number of Snowflake customers spending $1 million or more annually on its products surged 62% year over year, to 402. This suggests a greater share of Snowflake's revenue is coming from large organizations with more complex needs, which could be a long-term positive. It's cheaper to serve a few customers spending large sums.
- Second, Snowflake continues to hire more employees, especially in research and development roles. It had 6,659 staff members in Q2, an increase of 33% year over year, which suggests the company anticipates continued revenue growth in the future.
- Third, Snowflake is keeping its growth in operating expenses roughly in line with revenue growth, so its net losses are staying relatively constant. However, the non-GAAP (generally accepted accounting principles) free cash flow metric -- which strips out one-off and non-cash expenses like stock-based compensation -- soared by 50% to $88 million in Q2. That highlights the company's profit potential, which might be viewed positively by investors like Berkshire Hathaway.
Why Snowflake stock is a buy now
After Snowflake revised its fiscal 2024 full-year revenue forecast down in Q1, I warned investors to tread cautiously because we couldn't be sure if that was a sign of further weakness to come.
But Q2 painted a much brighter picture, and Snowflake's CFO Michael Scarpelli actually told investors that sentiment appeared to change for the better in July. He said customers were reengaging, and that many of Snowflake's largest partners renewed their contracts. He did warn, though, that it will take time for growth in consumption to catch up.
There was some evidence of that upbeat sentiment in the company's bookings, which increased 30% to $3.5 billion in Q2. Bookings are important to monitor because they're expected to convert to revenue in the future.
Snowflake stock currently trades at a price-to-sales (P/S) ratio of about 21, which is near the cheapest valuation since it became a publicly traded company -- down from a peak P/S of nearly 102. It's still far more expensive than other cloud stocks. Microsoft, for example, trades at a P/S ratio of about 11 (though it has a host of other businesses beyond cloud computing). Datadog, a cloud monitoring company, trades at a P/S ratio of about 16.
But I would argue Snowflake's runway for growth is much longer. Microsoft Azure generated $50 billion in revenue last fiscal year, so Snowflake's $3.5 billion in current bookings is a mere fraction of where it might be a decade from now if it can execute.
That brings me to the growing opportunity that is AI. According to Cathie Wood's Ark Investment Management, AI software companies could share in $14 trillion of revenue by 2030. Given the continuing expansion of Snowflake's AI product portfolio and its increasing investment in research and development, this company could be poised for a reacceleration in its revenue growth in the medium to long term.
While Snowflake stock still appears expensive today, investors willing to own it for the next five to 10 years could be handsomely rewarded. After all, there's a reason long-term investing is a key pillar of Buffett's strategy.
