Shares of Snowflake (SNOW 3.69%) tumbled at the end of February as the company not only posted unimpressive guidance, but also announced the surprise departure of CEO Frank Slootman. The stock was trading at around $230 heading into the earnings report, but Wednesday had dipped to $165.
The sudden, sharp sell-off appears extreme, particularly for a stock like Snowflake that can benefit from promising long-term trends in artificial intelligence (AI), which should increase demand for its cloud-based data platform. Is this an overreaction from Snowflake investors, or is it simply overdue for a stock that's trading at more than 20 times revenue and isn't yet profitable?
The quarter alone wasn't likely bad enough to trigger such a sell-off
Snowflake's quarterly operating loss expanded in the fourth quarter, which ended Jan. 31, from $239.8 million a year ago to $275.5 million. But revenue of $774.7 million was an increase of 32% year over year, and the company's net revenue retention rate remained high at 131%.
The one soft spot with respect to growth was the outlook for the first quarter, with the company projecting revenue to be between $745 million and $750 million, which lands slightly below analyst forecasts of $759 million.
While an increasing loss and a slightly lower-than-expected growth rate are a couple of reasons investors may have been feeling bearish on the results, it's unlikely those alone would have been enough to trigger the stock's 19% post-earnings decline last week.
The more likely catalyst behind the sell-off was the news that Slootman, who helped take the company public in 2020, is retiring, and that Sridhar Ramaswamy, who worked at Alphabet's Google for more than 15 years, is taking the reins as CEO.
Should a change in CEO worry investors?
A change in management isn't necessarily a cause for concern for investors, especially when it simply involves retirement. While it may have caught investors by surprise, that doesn't mean that the business is going in a wildly different direction or that it will become riskier moving forward.
Slootman said in a statement, "There is no better person than Sridhar to lead Snowflake into this next phase of growth and deliver on the opportunity ahead in AI and machine learning." Investors shouldn't forget that Apple lost its visionary CEO Steve Jobs in 2011 and continued to rise in value -- and today is one of the most valuable companies in the world.
Snowflake's fundamentals and valuation should be a bigger concern
What would worry me more as a prospective investor are things that have plagued Snowflake for a while, such as its lack of profitability and its high valuation. The tech stock recently traded at close to 22 times its trailing revenue, which is a steep multiple compared to other AI stocks.
SNOW PS Ratio data by YCharts
The company's cash flow is also unimpressive within the context of stock-based compensation (SBC). For fiscal year 2024, which ended on Jan. 31, Snowflake's operating cash flow less SBC was a negative $319 million.
While companies exclude SBC from their operating cash flow, I think it's important for investors to consider it as an expense -- if it were paid out in cash instead of stock, it would put the company's operating cash flow in a much different light. And in Snowflake's case, it highlights an underwhelming financial performance, especially when combined with its lack of profitability, which should raise flags for prospective investors.
Is Snowflake stock a buy today?
Snowflake's stock was overpriced before the sell-off (and arguably still is), and a lower valuation is warranted, but not because of a surprise change in the CEO. Investors likely did overreact to the news of the change in management. However, even at a reduced price, Snowflake may still not be a tempting buy right now given its lackluster financials.
The company is growing at a fast rate, but so are its losses, and the company is burning through cash if you add back SBC. Snowflake's stock is still up 25% over the past 12 months, but I wouldn't be surprised to see it go lower, as this is still a company that needs to prove it can be profitable and generate positive cash flow -- without the help of SBC.
