Don’t let the freezing name fool you — Snowflake (SNOW -0.96%) has been a hot growth stock lately. Shares of the cloud services company surged after the release of its latest quarterly results on August 24. The results indicated a continued blistering rate of revenue growth, which is expected to continue in the double digits.
But a quarter doesn’t make a stock, and in fact, Snowflake’s stock price has plummeted since the company’s splashy initial public offering (IPO) in late 2020. If you invested $10,000 in stock at its opening price, you would have a little less now. Let’s explore the dynamic behind this decline and determine if the stock is a buy.
A laminated stock?
Snowflake has the distinction of being the largest software industry IPO in history. Coming to the stock market – which included a $250 million buyout by none other than the once tech-averse Warren Buffett through his investment vehicle Berkshire Hathaway — the company raised a staggering $4 billion.
As for the resulting actions, however, Snowflake couldn’t maintain that level of popularity. The stock’s opening price on the first day of trading was $245 per share. As of this writing, it is changing hands at just over $186. So if you were one of the first investors to buy it on the stock exchange, that $10,000 would have bought you 40 shares (with $200 in change). These days, that stake is only worth $7,457, for a loss of 24%.
To some extent, Snowflake is being punished for simply being a tech growth stock in an environment where many investors shy away from such companies. Inflation and war in Ukraine are rocking economies around the world, and in this kind of atmosphere, many are abandoning more speculative stocks in favor of defensive tickers.
So no matter the underlying strength of Snowflake’s business model – which I believe is solid – and that ever-smoldering revenue growth, it still loses in the bottom line (it remains at an early stage in its development). Preferred defensive stocks tend to consistently land in the black, not the red.
Snowflake has actually done pretty well in terms of fundamentals throughout its brief life as a publicly traded company. In its recently released second quarter of fiscal 2023, it again managed to expand its revenue at a high double-digit rate, with the item growing 83% year-over-year to reach over $497 million. That was nearly $30 million more than the average analyst estimate. How’s that for a compelling beat?
The story was different in the end, as the net loss of nearly $223 million was significantly worse than analysts’ projections. It’s not a trivial amount, but again, it’s not much deeper than the nearly $190 million shortfall in the same period of fiscal 2022.
Let’s remember, though, that the name of the game with tech startups is to build a customer base and rack up revenue, booking losses along the way.
In addition, the super-success of IPOs has its privileges. Snowflake still has plenty of financial firepower in its arsenal. At the end of the quarter, its cash and short-term investments totaled just under $4 billion, down from the $4.1 billion-plus a year ago. This indicates good management of valuable assets and demonstrates that the business can continue to absorb net deficits if needed.
A solid operator
Meanwhile, Snowflake has a compelling business model that is proving sustainable in these tough times. It charges customers on a pay-per-use basis, rather than using the fashionable subscription model. Businesses that want to reduce their cloud-related expenses can therefore reduce the amount of cloud space they use at any given time, rather than committing to a potentially costly subscription.
The proof that customers love this model and that it incorporates organic growth is in the revenue retention rate. That rate — which measures how much the average Snowflake customer spends on the company’s services over time — soared to an impressive 171% in the second quarter. This means that longer-term customers collectively increased their spending by 71% over the course of a year. Even the most established technology service providers would be jealous.
Going forward, the company and analysts who follow it believe much more growth is in store for revenue from the products that make up the bulk of Snowflake’s revenue. In fact, the company raised its guidance for fiscal year 2023, albeit modestly. Its newly forecast range of $1.90 billion to nearly $1.92 billion would represent an improvement of at least 67% over the prior year’s tally.
With revenue improving so rapidly, these earnings losses should swing into positive territory sooner rather than later. Next, we should really see sentiment improving on Snowflake stocks. The cloud is a very good place to be, and this company is a worthy provider in this area. I would definitely consider charging it for any wallet.
Eric Volkman has no position in the stocks mentioned. The Motley Fool has positions in and recommends Berkshire Hathaway (B shares) and Snowflake Inc. The Motley Fool recommends the following options: long January 2023 $200 buy on Berkshire Hathaway (B shares), short January 2023 $200 sell on Berkshire Hathaway (B shares), and short calls of $265 in January 2023 on Berkshire Hathaway (B shares). The Motley Fool has a disclosure policy.