To The Moon

$Snowflake(SNOW)$

Introduction to Snowflake as an AI Stock

Snowflake is an intriguing AI stock to consider. AI relies heavily on data, and Snowflake stands out as one of the leading data companies, experiencing some of the fastest growth in the sector. Moreover, the company is growing profitably, with its cash flow from operations showing impressive improvement. But is the stock a buy at its current price? In this video, I’ll dive into Snowflake’s revenue growth, operating margins, returns on invested capital, and share my proprietary discounted cash flow (DCF) valuation. I’ll also look at valuation from a forward price-to-earnings and price-to-free cash flow perspective and provide an overall conclusion on whether Snowflake stock is a buy, hold, or sell at its current valuation.

Earning Overview

Snowflake Inc. reported its fourth-quarter earnings for the fiscal year 2024 on May 20, 2024. The company announced earnings per share (EPS) of $0.18, surpassing analyst expectations of $0.16. Revenue for the quarter reached $868.8 million, exceeding the projected $851.72 million.

Key Financial Metrics: Non-GAAP Operating Margin: Increased to 9% during Q4. Non-GAAP Adjusted Free Cash Flow Margin: Reported at 43%.

Product Revenue Forecast: For the first quarter of the fiscal year 2025, Snowflake projects product revenue between $955 million and $960 million. The full-year product revenue estimate stands at $4.28 billion, slightly above Wall Street's consensus of $4.23 billion.

Fundamental Analysis

Looking at Snowflake’s revenue growth history, one thing stands out: the deceleration. In 2021, the company saw revenue growing by over 100%, but that has slowed significantly since. However, in its most recent quarter, Snowflake still grew revenue by over 27%, which is a robust growth rate that any investor would likely be pleased with. If Snowflake can maintain this growth rate instead of facing further slowdowns, that will be a positive sign. A key metric I watch to forecast future revenue is the company’s net revenue retention rate. For Q4 of fiscal year 2025 (ending January 31, 2025), Snowflake reported a net revenue retention rate of 126%. This indicates that existing customers spend 26% more in their second year compared to their first, which signals strong customer satisfaction and bodes well for future revenue growth. Another important indicator is the company’s remaining performance obligations (RPO), which reached $6.9 billion in the most recent quarter, up from $5.7 billion the previous quarter. RPO eventually translates into revenue, which is a positive sign for future growth.

Guidance

Although Snowflake’s net revenue retention rate is strong, at 126%, and its remaining performance obligations (RPO) indicate future revenue growth, the company is still dependent on maintaining these high retention rates. If Snowflake experiences any customer churn or fails to meet customer expectations, it could impact future revenue growth. Additionally, as the company grows, sustaining such high retention and expansion rates may become increasingly challenging, especially as the market matures.

Snowflake has consistently guided for strong revenue growth, although the pace has slowed from its earlier hyper-growth rates. In its most recent earnings call, Snowflake projected a growth rate of around 27% year-over-year for the upcoming quarter, indicating a robust, albeit decelerating, expansion trajectory. This growth is driven by a combination of customer expansion, higher net revenue retention (currently 126%), and increasing demand for its data cloud services, particularly in AI and machine learning applications. The company’s guidance suggests that while it may not continue at the same explosive growth rates seen in 2021, it will maintain solid momentum.

Snowflake's profitability guidance remains a work in progress. While the company has made progress in improving its operating margins and cash flow, it has not yet achieved bottom-line profitability. Snowflake’s reliance on stock-based compensation is a factor that delays profitability and could continue to impact its earnings per share (EPS) for some time. The company’s guidance suggests that while it will likely continue to grow cash flow, achieving profitability could take longer, especially with its current reinvestment strategy to fund growth.

Free Cash Flow

Regarding profitability, Snowflake has been growing while improving its cash flow from operations. Its cash flow from operations as a percentage of sales has risen from -2% in 2021 to 26.5%, showing that more of the company’s revenue is being converted into cash. That’s an encouraging sign for any business. However, not everything is perfect. Snowflake’s return on invested capital (ROIC) is heading in the wrong direction, currently at -26%. While this is common for early-stage companies focused on growth, it’s worth noting that Snowflake is still not profitable on the bottom line. The company relies heavily on stock-based compensation, which is a non-cash expense that can dilute shareholders. As more shares are issued, future profits will be spread across a larger pool of shareholders, which could reduce earnings per share in the future.

Risks and Challenges

Valuation Risk Snowflake’s premium valuation is one of the most significant risks. At its current price, the stock is highly valued, particularly with a price-to-earnings (P/E) ratio of 98. For investors, this means that any slowdown in growth or failure to meet expectations could lead to a significant decline in stock value. The high price tag reflects high growth expectations, which may not always materialize, and the company would need to continuously meet or exceed these expectations to justify its valuation.

Profitability and Stock-Based Compensation Snowflake has not yet achieved profitability at the bottom line, and its reliance on stock-based compensation is a key risk. While stock-based compensation is a common practice, it can dilute shareholders’ stakes and reduce earnings per share when the company eventually reaches profitability. The impact of dilution can be significant, especially if the stock continues to issue large amounts of equity to retain and attract talent.

Competition Snowflake operates in a competitive environment, especially in the cloud data and analytics space, where companies like Amazon Web Services (AWS), Microsoft Azure, and Google Cloud are all vying for market share. While Snowflake has a unique offering, the larger cloud players have more resources, established customer bases, and lower pricing power, which could potentially put pressure on Snowflake’s growth and margins. This competition might intensify if these big players enhance their own data solutions or introduce new features that attract Snowflake's customers.

Dependence on AI MEME and Market FOMO Snowflake is positioned within the rapidly growing AI and data cloud market, which is both an opportunity and a challenge. While AI is expected to expand significantly over the next decade, any economic slowdown, changing regulatory environment, or shifts in AI-related technologies could disrupt market dynamics. If the broader AI market doesn’t grow at the anticipated pace, Snowflake’s growth prospects could be affected, especially as the company depends on these trends for long-term expansion.

Valuation

I recently updated my Snowflake cash flow valuation model, factoring in analysts' upgraded forecasts for the company's free cash flow over the next five years. After incorporating these updates, I raised my intrinsic value estimate for Snowflake from around $50 per share to $210 per share. I agree with Wall Street analysts’ upgrades, as the company has shown significant improvements in key metrics like net revenue retention and RPO, as well as strong revenue growth in an expanding market.

Valuation Analysis From a valuation perspective, Snowflake’s price-to-earnings (P/E) ratio of 98 makes the stock look expensive. However, its price-to-free-cash-flow (P/FCF) ratio of 58 suggests it is fairly valued. Snowflake certainly deserves a premium valuation, given its strong customer value proposition, a growing market, and limited competition in its space. Its competitors are not competing based on price but on innovation, which is a good sign for investors. Additionally, Snowflake operates in the rapidly expanding AI market, which is expected to grow significantly in the coming years.

Market sentiment

The market sentiment surrounding Snowflake has been largely positive, especially due to its role as a leader in the data and AI sectors. Investors are generally optimistic about its growth potential, as the company has established itself as a major player in the rapidly expanding data cloud space. Snowflake’s strong revenue growth, impressive customer retention metrics, and its positioning in the AI market contribute to this favorable sentiment.

However, there are mixed opinions about its valuation. While the company’s strong growth prospects and improving cash flow have led some analysts to boost their price targets, its high valuation — particularly in terms of price-to-earnings (P/E) — has raised concerns among more cautious investors. The stock’s premium price, driven by its market-leading position and growth prospects, means that investors are betting heavily on future performance, which introduces a degree of risk.

Snowflake's reliance on stock-based compensation has also been a point of scrutiny, as it could potentially dilute shareholders and affect future profitability. Despite these concerns, the overall market sentiment tends to lean towards a more optimistic outlook, particularly among growth-focused investors who are willing to accept higher risk in exchange for significant reward potential, especially with AI set to drive market expansion over the next decade.

Conclusion

So, do I think Snowflake stock is a buy, hold, or sell at its current valuation? Given its prospects, I believe the stock is a buy. However, I would note that this is a riskier buy due to its premium valuation and growth-dependent nature. Snowflake is better suited for risk-tolerant investors looking for high potential rewards despite the risks.

In conclusion, while Snowflake enjoys a favorable market sentiment, the stock remains a subject of debate due to its premium valuation, making it a more attractive choice for risk-tolerant investors with a long-term focus.

Disclaimer: I want to make it clear that I am not a financial advisor, and nothing I say is intended to be a recommendation to buy or sell any financial instrument. Additionally, it's important to remember that there are no guarantees or certainties in trading or investing, and you should never invest money that you can't afford to lose.

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