Is Snowflake a buy after profit?

Snowflake (NYSE: SNOW) has been a hot stock since its initial public offering (IPO) in 2020, earning a strong valuation for its meteoric growth and high-profile backers, including Warren Buffett himself. Until recently, the stock was reluctant to break away from its rich valuation.

But after the company announced its earnings for the fiscal year (ending Jan. 31), investors reacted negatively to the news, selling the stock at shouting distance from its all-time lows. Should investors buy the dip, or is Snowflake just starting to melt? Here’s what you need to know.

Was the trimester so bad?

The Data Infrastructure Company put up excellent numbers on the surface. Revenue grew 101% year-over-year in the latest quarter to $384 million and 106% for the full year to $1.2 billion. Management also announced that it has $2.6 billion in “performance bonds” – that is, contracted business that will be counted as revenue once they have rendered those services.

Image source: Getty Images.

Additionally, the number of customers spending $1 million or more on Snowflake increased 139% year-over-year to 184, and the company now has 5,944 total customers. The business model is primarily usage-based, resulting in a very high Net Revenue Retention Rate (NRR) of 178%. This number indicates how many additional customers spend once on the platform, and Snowflake’s NRR is among the highest on Wall Street.

Finally, Snowflake gross profit the margin grew rapidly, improving to 74% from 69% a year ago. Free movement of capital has nearly quintupled in the past year to $102 million, so Snowflake sees his finances starting to improve quickly, although technically he’s still losing money on the bottom line. Overall, it looks like Snowflake is a quality company, growing and moving its financial metrics in the right direction.

High Valuation Creates High Expectations

So what caused the negative market reaction? Management may have guided revenue growth of 66% for the coming fiscal year. Going from 106% revenue growth to 66% growth is a noticeable slowdown, and even if management is conservative, there’s not much room for error when you’re so richly valued.

Snowflake has been among the most expensive stocks on the market since its IPO, trading well on a price/sales ratio (P/S) of 100 at any given time, as shown in the graph. The stock’s valuation has fallen significantly thanks to a massive sell-off, but its price remains very high at a P/S of 64.

SNOW PS Ratio Chart

SNOW PS report given by Y-Charts

Ultimately, high valuations create high expectations; as a company priced for “perfection”, you cannot insinuate that your growth will slow significantly and expect the market not to punish you. This is why valuation is so important to investors; it’s how the market announces its expectations for a company, and a higher valuation leaves less room for disappointment.

Growth prospects still look solid

As far as Snowflake’s business is concerned, a 66% growth is not to be overlooked; investors should look at the company’s long-term growth track, which appears fairly intact. Snowflake’s nearly 6,000 customers still represent a tiny fraction of the millions of businesses worldwide, and data is becoming an increasingly important resource for businesses.

Snowflake’s consumption-based pricing is fully aligned with big data industry trends. People are generating more and more data every day, including internet activity, communications, social media, and more. As our world becomes more and more digital, companies are trying to understand this increased production of data to make the best decisions. Usage-based billing can capture this growing data volume.

The world created approximately 71 zettabytes (or 71 trillion gigabytes) of data in 2021, which could double by 2025. Snowflake’s cloud-native platform for storing, analyzing and exchanging data could have a very long sustainable double-digit growth track – which perhaps helps explain the stock’s high valuation so far.

Is Snowflake a buy?

Snowflake is a fundamentally sound company that could be a great long-term growth stock to own. Investors should celebrate the decline in stocks and, frankly, look for more air to exit the valuation.

Investors may want to consider a strategy of dollar-cost averaging to build up a position slowly over time. No one knows what a stock will do tomorrow or the day after, and waiting for the perfect moment could easily lead to investors missing Snowflake’s stock bottom entirely.

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justin pope has no position in the stocks mentioned. The Motley Fool owns and recommends Snowflake Inc. The Motley Fool has a disclosure policy.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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