Tech stock Nvidia saw its price surge 151% so far in 2024. Meanwhile, tech stock Snowflake (SNOW 0.44%) is trading down 40% over the same period. As it turns out, having strong connections to the artificial intelligence (AI) sector isn't enough on its own to create value. Investors also expect to see solid financial results.
Snowflake is a provider of cloud computing software solutions, and it was generating lightning-fast revenue growth when its stock first came public in 2020. That growth has since slowed, while the company continues to spend heavily developing new AI products and services at the same time. That increased spending is driving blowout losses at the bottom line. It's also got institutional investors rethinking their investment theses on Snowflake.
Top investment funds are heading for the exits
Warren Buffett's Berkshire Hathaway holding company bought Snowflake stock ahead of its initial public offering in 2020. While the price it paid wasn't made public, Berkshire likely paid around $120 per share. It rode the stock to its all-time high of $392 in late 2021, but it continued to hold on the way back down. Berkshire eventually sold its entire stake in Snowflake during the second quarter of 2024, when it was trading at around $135 per share.
Prolific technology investor Brad Gerstner led Snowflake's Series C investment round in 2015 (when it was still a private company) through his fund, Altimeter Capital, so he was a very early believer in its potential. The fund held 15.4 million Snowflake shares in the third quarter of 2023, but it has since slashed that position by 38%. It sold almost 3 million shares in the final quarter of 2023, followed by another 2.1 million shares in the first quarter of 2024, and a further 730,343 shares in the recent second quarter.
Why have Buffett and Gerstner seemingly turned bearish?
Snowflake is preparing for the AI revolution
Large, complex organizations that use multiple cloud providers often find that their data is heavily fragmented because it's spread across different platforms. Snowflake's Data Cloud is a revolutionary tool that can bring it together in a platform-agnostic way so the organization can analyze it more easily and extract valuable insights, which can be used to improve day-to-day operations.
Last year, Snowflake took the leap into AI products and services when it launched Cortex AI, which is designed to complement the Data Cloud. The Cortex platform allows businesses to combine their data with ready-made large language models (LLMs) like Meta Platforms' Llama 3, and Mistral Large, so they can build AI software applications.
Cortex also comes with several pre-built AI tools. Cortex Search uses natural language processing so developers can instantly retrieve data from large sets with a simple prompt. Then there is Document AI, which can rapidly extract valuable information from unstructured sources like contracts and invoices. In the past, that sort of data couldn't be processed unless a human worker manually read each document and transferred the information into a usable format.
At the conclusion of Snowflake's fiscal 2025 second quarter (ended July 31), around 2,500 of its 10,249 customers were using its AI products weekly. That suggests solid uptake, given that Cortex was only launched a year ago.
Image source: Getty Images.
Snowflake's revenue growth is decelerating
While everything highlighted above sounds great, AI isn't necessarily boosting Snowflake's financial results yet. The company generated $829.3 million in product revenue during Q2, a 30% year-over-year increase. That's a strong growth rate at face value, but it marked a significant deceleration from the 37% revenue growth Snowflake delivered in Q2 fiscal 2024 and the 83% number it delivered in Q2 fiscal 2023.
Snowflake spent a record $936 million on operating expenses during Q2, which was a 26% increase from the year-ago period. Its research and development spending -- which is used to develop new products -- hit $437 million for the quarter, which was a 40% jump.
In other words, Snowflake suffered slowing revenue growth despite spending more money on growth-oriented initiatives, which isn't a great sign. It also had big consequences for the company's bottom line, with its net loss coming in at $316.9 million for the quarter, a 40% surge from the same quarter last year.
There is some evidence the spending will pay off in the future because Snowflake's remaining performance obligations (RPOs) jumped 48% to $5.2 billion during Q2. The company expects to convert half of that order backlog into revenue within the next 12 months, but it doesn't offer guidance for the rest -- so while it's possible accelerated revenue growth could follow, it isn't a certainty.
Snowflake's valuation is another drawback
Despite the 71% decline in Snowflake stock from its all-time high, it can be argued that it's still quite expensive. Based on the company's trailing-12-month product revenue of $3.1 billion and its market capitalization of $38.2 billion, its stock trades at a price-to-sales (P/S) ratio of 12.
It's difficult to compare Snowflake to other publicly traded companies because of its unique product portfolio. However, Microsoft, Amazon, and Alphabet are the three largest providers of cloud services in the world, and they also happen to be leaders in the AI space.
Based on its P/S ratio, Snowflake is marginally cheaper than Microsoft, but it's far more expensive than Amazon and Alphabet:
I think Snowflake's valuation is still too high on that basis. All three tech giants have track records spanning decades, and each one is highly profitable, while Snowflake continues to burn significant amounts of money.
In my opinion, Snowflake stock was never a good fit for Berkshire's portfolio. Buffett likes to invest in companies with steady growth and robust profitability because they often have the flexibility to return money to shareholders via dividends and stock buybacks. Snowflake does have a buyback program, but it might not be sustainable, given the company's growing losses, and that probably also rules out dividend payments in the foreseeable future.
Snowflake is in the wheelhouse of Gerstner and his Altimeter fund, though, because he focuses solely on technology stocks. That's probably why he still owns 9.2 million shares in the company. He added to his holdings in stocks like Alphabet, Amazon, and Uber Technologies in the first half of this year, and since they might have better prospects than Snowflake in the near term, don't be surprised if he continues selling it to free up capital for those opportunities.
