Shares of Snowflake (SNOW 0.53%) fell 14.2% in March, according to data provided by S&P Global Market Intelligence. Investors reacted negatively to the company's quarterly earnings report on Feb. 28, in which it issued disappointing forecasts for next year and announced the departure of its CEO. This wasn't followed up with any more bad news in March, but it seems the market was skeptical of its expensive valuation ratios in a month that saw value stocks outpace growth stocks.
Snowflake's February quarterly report looked good on the surface, but the stock still tumbled
The company exceeded Wall Street's expectations with $775 million in revenue, marking more than 30% growth. Remaining performance obligations, which contractually obligated revenue that will be recognized in the future, were up more than 40%.
Snowflake also produced $320 million in free cash flow, so it efficiently translated sales expansion into cash returns. The company reported a phenomenal 131% net dollar retention figure, which indicates it is keeping a high percentage of its customers and upselling existing accounts. Those are comprehensively strong results.
Image source: Getty Images.
Snowflake shares still dropped in the days following that report. Its sales guidance calls for 26%-27% growth next year, significantly lower than Wall Street's expectations. That's a healthy pace of expansion but represents a meaningful slowdown, which is generally bad news for growth stocks.
Snowflake also announced that its CEO is retiring. That's not necessarily bad news, but uncertainty often creates volatility for stocks with expensive valuations, especially if investors are feeling lower risk tolerance in general.
Incoming CEO Sridhar Ramaswamy was promoted from senior vice president of AI (artificial intelligence) at Snowflake, so he has executive experience in the company's key growth avenue. That should provide confidence that the company can continue its operational excellence.
Valuation is at the heart of the issue
A 14% sell-off seems harsh on the back of news that was modestly bad at worst. Snowflake's March performance is a reminder of the volatility inherent in growth stocks with expensive valuations. At the start of the month, the stock had a forward price-to-earnings (PE) ratio of nearly 200, a forward price-to-sales ratio of over 18, and a price-to-free-cash-flow above 70.
SNOW PS Ratio (Forward) data by YCharts. PS Ratio = price-to-sales ratio. PE Ratio = price-to-earnings ratio.
That level of valuation generally isn't possible without an exceptionally high growth rate and performance that consistently exceeds investor expectations. Snowflake expects revenue growth to decelerate this year, falling somewhere between 25% and 30%.
Value stocks outperformed growth stocks in March, indicating waning risk tolerance. Investors are scrutinizing their bullish forecasts. Expensive stocks are often on the chopping block in those conditions.
Snowflake's business has outstanding potential for growth and future profits, but the stock's valuation remains expensive. This shouldn't necessarily sway long-term investors, but volatility will be part of the story moving forward.
