Snowflake (SNOW 3.69%) has become a popular artificial intelligence (AI) stock for a good reason: It fuels AI innovation. AI is built on the back of data, and Snowflake's business of data collection, storage, and processing makes it a perfect AI-accompanying investment.
But is the stock a top option to own in 2024? Let's find out.
Snowflake's data cloud is critical for AI proliferation
Snowflake refers to its product as the data cloud. Essentially, it allows users to compile unstructured, semi-structured, or structured data from their various sources. Then, users can efficiently store it on any cloud provider system (like Amazon Web Services, Google Cloud, or Azure). By storing their data using Snowflake instead of one of the cloud providers' systems, users can easily switch from one product to another without fear of being locked into unreasonable contracts.
Once this data is collected, Snowflake allows its customers to harness its power to feed applications or perform data science to discover new insights. Finally, if a company doesn't have a use for its data, it can sell it on the Snowflake Marketplace.
This allows AI companies looking for a particular dataset to purchase it from a business that has it. Data transfer like this is key in AI proliferation, as many AI start-ups don't have access to the information they need.
Snowflake customers are also incredibly satisfied with the product, as it has achieved a 100% Dresner Customer Satisfaction Score for six consecutive years. With nearly 9,000 customers (up 24% year over year) and 436 clients that spend at least $1 million annually (up 52% year over year), Snowflake also has a large customer base.
But there is one issue with Snowflake's finances that investors must be aware of.
Snowflake's profitability isn't improving
In the third quarter of fiscal year 2024 (ended Oct. 31), Snowflake's product revenue rose 34% year over year to $699 million. That's strong growth, but it is much slower than its previous growth rates.
SNOW Revenue (Quarterly YoY Growth) data by YCharts
With Snowflake's slowing growth, management should be starting to think about profits. However, that's not the case.
In Q3, Snowflake's operating loss increased from $206 million in 2022 to $261 million in 2023. Revenue growth hardly offset this rise, so Snowflake's operating margin barely improved from a 41% loss in 2022 to a 36% loss in 2023. A large part of Snowflake's operating expenses is a massive stock-based compensation bill. In Q3, Snowflake paid its employees $298 million in stock. That caused its outstanding shares to swell by 2.9%, creating an additional headwind for Snowflake shareholders.
This could be offset if Snowflake traded at a reasonable price, but at 23 times sales, it's priced for perfection.
SNOW PS Ratio data by YCharts
If Snowflake could snap its fingers and achieve its long-term target non-GAAP operating margin of 25% combined with a 20% tax rate, it would produce about $524 million in net income annually. Dividing its current market cap by that figure yields its hypothetical price-to-earnings ratio, which would be 118.
Keep in mind that these are non-GAAP earnings, so they exclude stock-based compensation (which is a big factor for Snowflake). If you add the effects of that practice in, the stock becomes much more expensive.
As a result, I'm not considering buying the stock now (although I own some shares already). Snowflake's stock is far from cheap, and the market has too many better values. While Snowflake's business will likely succeed and grow, those expectations are already baked into the stock price.
