Markets

Is Snowflake Stock Overpriced?

Recent-IPO darling Snowflake (NYSE: SNOW) deserves its high valuation. The data-warehouse-as-a-service specialist has been growing revenue at a fast pace over the last several years, and it remains exposed to the long-term growth opportunities that cloud and data analytics represent.

But the company's lofty valuation suggests the market expects phenomenal long-term performance. Does that mean that Snowflake's stock overpriced, despite the company's attractive potential?

Phenomenal growth in data storage and analysis

As enterprises have been digitizing their operations, they have been accumulating vast amounts of data. That trend isn't likely to wane: Research outfit IDC estimates the amount of worldwide data will grow at a compound annual rate (CAGR) of 61% by 2025.

The good thing is companies can exploit that knowledge to make business decisions. However, until recently, analyzing such a growing amount of data required cumbersome processes, hardware, and software.

Man touching cloud with padlock icon on network connection.

Image source: Getty Images.

Thus, Snowflake leveraged cloud computing to simplify big data management and analysis. For instance, its platform doesn't require data analysts to process and organize data before storing it for analysis. And its customers can use and scale resources on-demand from any of the major public cloud vendors, Amazon, Microsoft, and Alphabet's Google.

In addition, the company offers more than big data storing and analysis solutions. It integrates with third-party tools to complement its capabilities. And it developed a unique and differentiating marketplace that allows customers to securely exchange or sell data.

With strong execution, last-quarter revenue jumped 120.7% to $133.1 million as the company attracted many new customers. At the end of July, the number of customers surged to 3,117, up from 1,547 one year ago. In addition, the net retention rate of 158% over the last two quarters shows existing customers have significantly increased their spendings compared to last year -- a strong indicator of the company's attractive offering.

Granted, losses of $77.6 million during Q2 remained elevated as high sales and marketing expenses of $92.7 million fueled that growth. But management is prioritizing growth to capture Snowflake's large market opportunity, which it estimates at $81 billion.

Competition in the cloud big data market

Given these impressive results, the company's market cap of $73.3 billion corresponds to 182 times trailing-12-month sales of $402.7 million while losses reached $343 million. Such a rich valuation corresponds to phenomenal expectations, but investors should be aware that competition represents a significant risk.

For instance, the three large public cloud vendors Snowflake relies on aren't likely to negotiate generous terms as they propose competing cloud big data products. That will prevent Snowflake from significantly improving its gross margin. Also, the tech giants could ramp up their efforts to mitigate Snowflake's phenomenal growth by leveraging their large computing infrastructure and superior financial resources to compete on prices.

Besides, some other players have been improving their offerings to address the public cloud market and compete with Snowflake. For instance, the legacy on-premises big data specialist Cloudera adapted its on-premises portfolio with its Cloudera data platform to cover hybrid cloud environments (any combination of public and private clouds). In comparison, Snowflake offers only public cloud solutions.

Overpriced stock

With innovations, that competitive environment will keep evolving. In that regard, investors should keep a close watch on Snowflake over the next few weeks. The company may reveal new features and products during its data cloud summit on Nov. 17. And it will report its first quarterly earnings as a public company by the end of November -- at a date yet to be announced.

However, even if those events confirm Snowflake's strong growth potential, the stock remains overpriced at 130 times analysts' full-year revenue forecast of $565.8 million. I'd rather wait for a strong pullback in price before opening a position.

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John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Teresa Kersten, an employee of LinkedIn, a Microsoft subsidiary, is a member of The Motley Fool's board of directors. Herve Blandin has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), Amazon, and Microsoft. The Motley Fool recommends Snowflake Inc and recommends the following options: long January 2021 $85 calls on Microsoft, short January 2021 $115 calls on Microsoft, short January 2022 $1940 calls on Amazon, and long January 2022 $1920 calls on Amazon. The Motley Fool has a disclosure policy.

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