Two phrases that are hardly seen in the same sentence are Warren Buffett and artificial intelligence (AI). Yet, in his investment portfolio at Berkshire Hathaway, Buffett has a clear-cut AI play. Snowflake (SNOW 3.69%) makes up just 0.3% of Berkshire Hathaway's portfolio the company has owned Snowflake since it debuted on the public markets in 2020.
While Buffett himself may not have made the investment (it was likely Todd Combs and Ted Weschler, two well-known portfolio managers at Berkshire Hathaway), he likely had to sign off on the deal since buying it broke a few of his core rules. But if you're willing to break the rules of one of the greatest investors of all time, then it's likely Snowflake could be a pretty remarkable investment. So, should you buy Snowflake? Let's find out.
Snowflake's data management capabilities are unparalleled
Creating an AI model requires a vast amount of data. While this data can come from multiple sources, the problem is storing it once you've either collected it or purchased it. If you're collecting it, sometimes data doesn't come in a nice, clean format; it could be unstructured.
Snowflake's products assist with data collection, storage, and processing and are almost necessary to collect large datasets. Snowflake can optimize storage when storing and collecting data, allowing its clients to spend less on cloud computing capacity. Additionally, if a client wants to sell the data package it has assembled, it can do that through the Snowflake marketplace. This is a key development for AI, as most developers don't have access to the datasets they need to train AI models properly.
These datasets can also be harnessed to funnel straight into various applications, giving Snowflake's clients the most up-to-date information possible.
Essentially, if you've got data, Snowflake is there to help. As a testament to its usefulness, the stock has put up some pretty incredible growth numbers over the past few years.
Slowing revenue growth is a concern for Snowflake's profitability goals
In the second quarter of fiscal year 2024 (ended July 31), Snowflake's revenue grew 36% year over year to $674 million. It's also seeing its customer base rapidly expand its spending, as 40 customers now spend at least $1 million annually with Snowflake, which was up 62%. However, this is a slowdown from previous quarters.
Data source: YCharts
As Snowflake becomes a larger business, it is more difficult to increase revenue at the lightning-fast pace it did when the company was smaller. Although this is expected, it's also an issue because Snowflake has yet to turn a profit (yes, Berkshire Hathaway purchased an unprofitable company!).
In Q2, Snowflake posted a net loss of $227 million, a 40% loss margin. While that's better than last year's 47% loss margin, the company still has a long way to go before breaking even. Stock-based compensation is the culprit for not breaking even, as Snowflake shelled out $300 million in stock to its employees in Q2 alone. Snowflake is showing no restraint either, as this expense rose 44% year over year, faster than revenue rose.
This is a crucial area for investors, as Snowflake must eventually make the leap to become profitable.
It's also why the company needs to be valued on a price-to-sales (P/S) basis because any other metric is useless.
Data source: YCharts
At about 20 times sales, Snowflake isn't a cheap stock, but it is near the lowest it has been valued on the public markets.
So, should you buy this richly valued, unprofitable stock with slowing revenue? I'd say it depends. Snowflake's revenue growth is slowing thanks to macroeconomic factors driving customers to optimize their cloud spending. Big data is a massive business trend, and I'd expect it to ramp up when IT budgets increase with an improving economy. We're also in the early stages of an AI revolution, and many potential clients haven't figured out the vast amount of data needed to create a useful AI model.
With both those catalysts on the horizon, I'd say Snowflake is somewhat interesting here. However, until it shows signs of either of those potentials, I'm keeping a low percentage of my portfolio in Snowflake stock (less than 1%). That way, if it takes off, I have a solid gain, but if it doesn't, I'm not exposed to a significant loss.
Snowflake has great potential, but the headlines don't back it up right now.
