Snowflake (SNOW 3.69%) stock jumped sharply higher following its latest earnings results for the fiscal 2024 third quarter (ended Oct. 31). Revenue growth was lower than the previous quarter, but investors see evidence of improving growth trends in the near term after Snowflake reported cloud consumption on its platform was up 500% in October since last year.
Let's look at the latest financial results, and whether investors should buy the stock now.
There's one thing Wall Street didn't like in Snowflake's earnings report
The declining rate of revenue growth has been a heavy anchor on this stock trading at an expensive valuation. Through the first three quarters of fiscal 2024, Snowflake has reported top-line growth of 48%, 36%, and 32% (its most recent result). Though growth is decelerating, the relatively small decline from fiscal Q2 suggests the headwinds impacting cloud spending across the industry are almost over.
Snowflake charges customers based on the consumption of storage and resources used on the platform, so it was encouraging to see management call out improving consumption trends as a reason for upgrading its outlook. The company is now calling for full-year revenue of $2.65 billion, representing 37% year-over-year growth -- a small uptick over the previous guidance of $2.60 billion.
However, some Wall Street analysts believe Snowflake is still facing an uphill battle in the near term. Analysts noted the decline in Snowflake's revenue retention rate, which looks back over the last two years to show the growth in spending from existing customers. This number was hovering above 170% a year ago but dipped each quarter this year falling to 135% in the fiscal third quarter. Basically, any number above 125% is good for a small software business, but Snowflake's has been falling too fast for comfort.
Snowflake's revenue retention rate peaked at 178% in the fiscal 2022 fourth quarter before decelerating as customers started tightening their cloud budgets amid the macroeconomic headwinds last year.
While the consumption increase in October doesn't make a trend, it's telling that management feels confident enough about what it's seeing in the business to raise revenue guidance.
Moreover, Snowflake's improved guidance reflects what other leading tech companies are seeing in their respective markets. Microsoft, for example, noted an improving PC market for better growth in Windows software. Additionally, Amazon reported stabilizing growth in its cloud services unit.
In addition to an improving outlook for the tech sector, Snowflake has several new products coming to its platform to drive more growth. These services give customers more options to use artificial intelligence (AI) with their data, which could ultimately benefit the stock.
Document AI just went into preview on Snowflake. This service comes from the acquisition of Applica in 2022 and helps businesses perform analytic processing on unstructured documents, which makes up 80% of the world's data. There's a huge opportunity for Snowflake with Document AI, but there are several other new products, such as Cortex AI and Snowpark Container Services, that are seeing high customer interest and could be important catalysts for growth in 2024 and beyond.
A long-term buy and hold
The biggest obstacle for the stock remains the high valuation. By fiscal 2029, management is still guiding for approximately $10 billion in revenue and a 30% free-cash-flow margin, which would translate to $3 billion of free cash flow. Using the company's current market cap of $61 billion, investors are being asked to pay over 20 times free cash flow based on management's target for five years from now.
The stock can still deliver good returns from here since Snowflake's recurring revenue and massive growth opportunity is deserving of a premium valuation. Consider that a mature software business like Microsoft still commands a valuation of 44 times free cash flow right now. If Snowflake is still trading for a similar valuation by fiscal 2029, the stock could more than double in value.
It's never easy to predict a company's future share price since there are so many unknowns to consider, especially with the broader economy. If Snowflake meets management's long-term guidance, it's possible for the stock to keep climbing, but I would only suggest buying the stock if you're willing to hold it for at least 10 years.
Snowflake is a wide-moat business with a growing customer base and an expanding product offering. It's a key data service offered on all the major cloud platforms and dozens of others. With that in mind, a long-term buy-and-hold mindset is still essential to earn satisfactory returns with this innovative cloud company.
