There's a saying about insider stock trading activity: Executives sell for many reasons, but there's only one reason to buy. With that in mind, Snowflake (SNOW -0.44%)'s new CEO, Sridhar Ramaswamy, made headlines after disclosing a $5 million purchase of company stock.
There's much to like about the data lake and analytics company, which is also a holding in Berkshire Hathaway's portfolio. But when insiders buy, it's usually a statement. What is Ramaswamy saying about the stock today?
Why insiders buy stock
High-level executives within a corporation must disclose their stock buying and selling activities. These insiders may sell shares for many reasons. For some, stock may represent the bulk of their compensation, so they must liquidate shares for income. Insiders sell for tax reasons, too. And yes, sometimes an insider loses confidence in the company's direction, or feels the stock is overvalued and wants to cash in.
However, when insiders buy, it's most often because they believe the stock is going to go up. Such purchases can also help instill confidence among outside shareholders. A business leader can praise their company all they want, but putting your money where your mouth is speaks the loudest.
Ramaswamy could also have another reason for buying stock. For a newly appointed CEO (he took on the role in February), buying company shares is a significant vote of confidence in the business. Berkshire Hathaway's CEO-in-waiting, Greg Abel, did something similar, adding more shares of the conglomerate to his own portfolio after it was announced he would eventually succeed Warren Buffett in the top job.
Does Snowflake's valuation justify buying?
Snowflake went public with a lot of hype. In its early days, it traded at a price-to-sales ratio (P/S) near 200, among the highest valuations on Wall Street. From that vantage point, today's P/S of 19 looks like a bargain.
In broader terms, 19 times revenue is a steep valuation for most companies. To justify such a valuation, the company must be growing. It also helps if the business is profitable, so investors can know they're paying for quality revenue. Revenue doesn't mean as much if the company's losing money to bring it in.
SNOW PS Ratio (Forward) data by YCharts.
Snowflake is growing, as reflected in the lower forward P/S ratio, which is based on analyst estimates for this year. On average, analysts believe Snowflake's revenue will increase from $3.4 billion this year to $12 billion by 2030. The company is also quite profitable, converting 42% of its sales to free cash flow. The company's not profitable on a GAAP (generally accepted accounting principles) basis yet, but it should reach that milestone as its revenue grows, given its strong free-cash-flow generation.
Should retail investors buy the stock?
Trying to predict what Wall Street will pay for Snowflake's business over time is almost a wild goose chase. Valuations can wildly fluctuate. The bottom line is that its shares are nearly the cheapest they have been since it went public.
Artificial intelligence systems depend on vast quantities of good data, and Snowflake is well positioned to become a key cog in how companies store and use that data over the coming years. That's exciting, but Wall Street tends to price anticipated future success into exciting stocks. Investors would probably be best served to use a dollar-cost average strategy here, buying shares bit by bit, and slowly building a position over time.
If the share price goes down, you'll lower your average cost. If they go up, great! You'll be glad you started buying earlier. Snowflake was once valued at a stratospheric level, but today, it is at least trading within the range of its enterprise software peers.
