Although stocks are rising again, many investors have learned a harsh lesson in recent years. High valuations in the previous bull market often left investors holding the bag in the 2022 bear market when stock prices fell. This prompted investors to pay closer attention to one factor -- valuation.
Snowflake (SNOW 3.69%) was no exception to this issue, as it lost as much as 70% of its value at a low point in the market. Nonetheless, Warren Buffett's team at Berkshire Hathaway (BRK.A -0.76%) (BRK.B -0.69%) has owned a stake in the company since before its IPO, so an elevated valuation did not prevent a partial recovery. With the indexes in a new bull market, investors have good reason for ignoring this valuation.
Snowflake and valuation
On the surface, Snowflake stock appears overvalued and risky. The company has not yet turned profitable, meaning it does not have a P/E ratio. Moreover, at a price-to-sales (P/S) ratio of 25, it is nearly 10 times the S&P 500's average P/S ratio of 2.7.
However, even at its record low price of about $119 per share, it sold for about 26 times sales. Also, even as sales improved and the stock partially recovered, the stock has never sold below a P/S ratio of 18.
SNOW PS Ratio data by YCharts
Furthermore, as mentioned before, this attracted an investment from Berkshire Hathaway. From what we know about Buffett's investment philosophy, a Buffett lieutenant likely drove this purchase.
Nonetheless, it is notable that the company's value proposition was compelling enough to make these typically risk-averse investors take a chance on the stock. This factor may have persuaded other investors to take a closer look at Snowflake.
Why Snowflake stock is so attractive
Buffett's team likely took the chance it did because Snowflake is an investor's dream. It provides software designed to store, manage, and secure data in the cloud.
This is advantageous since storing data on private servers can lead to multiple copies. If different users make different updates, it becomes difficult to tell which version of the data is accurate. With the data cloud, administrators can monitor permissions and changes from a central repository, giving organizations more confidence in their data.
Moreover, Snowflake is interoperable, meaning it can work seamlessly regardless of which company maintains the customer's cloud infrastructure. So powerful is this advantage that competitors such as Amazon (NASDAQ: AMZN) have promoted Snowflake over its own data cloud product. As of the third quarter of fiscal 2024 (ended Oct. 31, 2023), its customer base of more than 8,900 grew 24% over the previous year.
Additionally, its customers pay for Snowflake by usage. Thus, when customers make greater use of the product, the company earns more revenue. This drives its 135% net revenue retention, which means the average long-term customer spent 35% more on the platform than they did one year ago.
Consequently, revenue for the first nine months of fiscal 2024 was just over $2.0 billion, a yearly increase of 38%. Although the company lost $667 million during that period, it holds more than $3.5 billion in liquidity. This should give Snowflake the runway needed to improve its financials without depending on increased debt or more stock issuance.
Consider Snowflake
Given Snowflake's positioning in the market, investors should consider the stock despite its high valuation. Indeed, the sales multiple could fall if sentiment becomes bearish, and achieving profitability could take years. Such factors are usually reasons to sell a stock instead of buying.
However, it offers a compelling value proposition when its competitors promote Snowflake above their own product. Furthermore, the net revenue retention should remain high for a long time to come since greater usage brings the company higher revenue. Such factors should place upward pressure on the cloud stock's price and mitigate the effects of a market downturn.
