Investors continue to flock toward the artificial intelligence (AI) market in droves, ditching their former darlings in the cloud software space, and even forgetting that there might still be value in that "old" technology market.
Case in point, consider Snowflake (SNOW 3.69%). When it delivered its fourth-quarter earnings report on Feb. 28, it also made a surprise announcement -- that CEO Frank Slootman was retiring. In the wake of all that, its shares got clobbered again.
The market may have punished Snowflake, but following that slump, I was finally ready to place my first buy order for the stock.
Snowflake's "bad" year?
Slootman is stepping down as CEO, but he'll remain chairman of the board. Sridhar Ramaswamy, who came over to Snowflake last year when it bought his AI-powered enterprise search start-up, Neeva, will assume the CEO role.
The messaging from Ramaswamy was clear: Snowflake will keep innovating new products and use cases for its data storage services, and built-in compute capabilities. In this new era of rapid generative AI infrastructure build-out (which is being spearheaded by Nvidia), surely Snowflake can capture more market share. After all, research firm Gartner predicts that in 2024, the growth in end-user spending on cloud services will actually accelerate to about 20%, up from an 18% growth pace in 2023.
Broadly speaking, cloud software stocks are emerging from hibernation after the bear market of the last couple of years. But Snowflake must not have gotten the memo yet. After product revenue (the bulk of its sales, based on customer consumption of its software services) grew by 38% in its fiscal 2024 (which ended in January), management is forecasting that the rate of expansion will melt to just 22% in fiscal 2025, with product revenue expected to be about $3.25 billion.
This outlook is likely the main reason the market collectively took a step back and sold Snowflake off after the last update.
Will the new CEO be up for the challenge?
The good news is that new CEO Ramaswamy has a deep software engineering pedigree, having served in top roles at Alphabet's Google. Over the course of his 15-year tenure there, he helped expand its advertising business from a relatively small operation to one generating in excess of $100 billion a year. So I wouldn't write off Snowflake's ability to continue to scale up under Ramaswamy.
The company will, of course, need to prove it. But with the stock getting lost again in a blizzard of investor selling, it's now more reasonably priced than ever. That's all relative, to be sure: It's still trading at more than 70 times free cash flow as of this writing, and one must also factor in the expectations for a sub-30% revenue growth rate. For its current valuation to make sense, Snowflake will need to generate several years of double-digit-percentage revenue growth and profit margin increases.
But those aren't unreasonable expectations for a top software enterprise. Lots of companies in IT that are many decades old still put up high rates of earnings growth. Snowflake will need to demonstrate it has this kind of staying power, though. This is why I decided to buy Snowflake cautiously. I opened a small starter position that I will add to if the company shows that it can reinvigorate its prospects and keep ramping up its profit margins along the way. I'll likely utilize a quarterly dollar-cost averaging plan, assuming the growth story continues to play out.
Though Snowflake is entering a new phase of its history -- one in which it will have to deal with more moderate expectations -- I like its prospects in the vast and still fast-growing cloud computing industry. Demand for big data sets and management of that data isn't going to diminish as the use of AI platforms expands, so Snowflake looks like a reasonable long-term buy to me. Time will tell.
