Snowflake stocks (ticker: SNOW) have officially started trading today on NYSE. The cloud-based data management company priced its IPO at $120 per share. During its very first trading day, Snowflake has become the hot new thing and SNOW stocks have already gone up 112% from its IPO price. While some investors are doubling their bets on this software startup, we have to ask – is it worth it to invest in Snowflake IPO?
What is Snowflake and what does it do?
As a B2B software company founded in 2012, Snowflake is not a household name like Tesla or Apple. The company doesn’t provide consumer products and instead mainly serves large companies and provides cloud-based data solutions. Snowflake’s services cover three major layers:
- Data storage
- Computation
- and cloud services
Essentially, the company enables large companies to unify all their data for analytics with ease, security, and at a low cost. As big data begins to dominate many industries, Snowflake provides a one-stop solution to corporations to extract more value from their data and even build data applications.
How does Snowflake make money?
Snowflake is a Software-as-a-Service (SaaS) company. Unlike some companies using the subscription model, SNOW charges its user a fee for data storage, computation, and transfer. The more storage you use the more you pay. In 2019, the company had a revenue of $264.7 million, a 174% growth from the previous year.
Why is Snowflake so popular?
It’s not often for a B2B company to receive so much attention from the market and investors. After all, most people who invest in Snowflake stocks are not the company’s target users. The first driver for the buzz around SNOW stocks is the fact that Warren Buffett’s Berkshire is investing in SNOW. Along with Salesforce, Berkshire Hathaway is taking 4.7 million shares of SNOW. Berkshire will also buy another 4 million shares in a secondary transaction, according to Snowflake’s S-1 filing with the SEC.
The fact that Buffett is investing in Snowflake is a vote of confidence for many investors. As a value investor, Buffett has not been an avid investor in the tech space, holding mostly financial and consumer companies. Some tech stocks that made the list include AAPL and AMZN. Both of these companies are well-established and have strong cash flow and profit generation. In comparison, SNOW is a young startup. Although Snowflake’s revenue is growing fast, the company isn’t profitable yet, making SNOW an exception to Buffett’s investment philosophy. Consequently, investors take Buffett’s purchase as a sign of the company’s long-term feasibility and potentials.
The second reason behind the incredible performance of SNOW stock is the large market appetite for tech stocks. Despite the Coronavirus market crash, 2020 has spelled blessings for tech stocks, who led the recovery of the stock market from its March low. The low interest rate and an accommodating central bank pushed bond yield to record lows. As a result, a lot of investors are putting their money into the stock market, many of whom are first-time investors. These young investors are buying stocks from tech companies they know well from Apple to Tesla, leading to a strong bull market for tech stocks. While some might argue that a second dot-com bubble is likely, the strong performance of SNOW proves that investors cannot get enough of tech stocks.
Should you Invest in Snowflake?
The incredible growth of SNOW today might lure many investors to try their luck in the stock. But before you open your wallet, let’s look at the company’s strengths and risk factors in more details to decide if you should invest in SNOW stocks.
Snowflake Strengths
Strong demand for tech stocks
The current market environment is extremely interesting. On one hand, many tech stocks are overvalued due to the recent market growth. For example, Tesla stock has gone up by more than 400% since the beginning of the year. On the other hand, investors should not ignore the market demand and dismiss the growth simply as “the second dot-com bubble”. The Quantitative Easing program and the low interest rate injected a large amount of money into the economy and the market. At the same time, the low yields in the bond market means that investors are putting more money into risk assets such as stocks. This demand is likely to stay as long as the Fed maintains the same monetary policies. Consequently, this strong demand for tech stock can provide a strong bullish factor for Snowflake to continue to grow.
Strong growth in a promising market
In addition to the market sentiment, Snowflake has a competitive product in a growing industry. Data is the future. Big data and cloud computing provide innovations and new opportunities and the revolution has just begun. The strength of the Snowflake’s product is shown by the fast top-line growth.
The revenue growth from January 2019 to 2020 is 174% while the six-month revenue growth from July 2019 to July 2020 is 133%. At the same time, the company’s profitability measures are also improving. The gross margin of Snowflake went from 53% in July 2019 to 62% in July 2020. The company’s operating margin also improved from -158% in July 2019 to -58% in July 2020.
| Snowflake | 31-Jul-19 | 31-Jul-20 | YtY Change |
| Gross margin | 53% | 62% | 9% |
| Operating margin | -158% | -58% | 100% |
Snowflake’s ability to swiftly grow its revenue is very promising, especially to investors who are interesting in this space. At the same time, the improving gross and operating margins suggest fiscal responsibility and increasing viability.
Snowflake Risk Factors
Profitability remains to be seen
Despite Snowflake’s strong revenue growth and improving margins, the company has yet to make a profit. The company lost $178 million in 2018 and $328.5 million in 2019. Investing in unprofitable companies is always challenging. After all, investing in a company without profits is to invest in its potentials. But given that Snowflake has only been in the business for eight years, there is limited data to estimate the true value of the company. Although investors can make forecasts on the company’s future performance based on lofty assumptions, the limited data and fast-changing competitive landscape limit the visibility into SNOW’s financial future. This uncertainty makes investing in Snowflake rather risky.
Fierce competition
Data warehousing is an industry with promising potentials but also stiff competition. Snowflake’s product has certain competitive advantages include its ease of administration, security, and strong analytics. However, the company’s competitors include Amazon Web Services, Azure, and GCP. Some of these competitors have better name recognition, partnerships, and financial resources to quickly adapt and displace Snowflake’s product before the company even becomes profitable. Consequently, investing in Snowflake is to invest in its ability to continue to innovate and maintain its competitive advantage. However, staying competitive against such powerful players and many newcomers could prove challenging.
Additionally, a majority of Snowflake’s business is run on AWS. This provides AWS the opportunity to develop its own production with better native integration and even increase the cost of service for Snowflake, forcing SNOW to charge higher prices and lose customers.
High valuation
Lastly, the current price level for Snowflake appears to be overvalued. As we mentioned above, with limited data, it’s nearly impossible for investors to accurately evaluate SNOW stocks. However, we can look at the company’s valuation in comparison to others. The $120 IPO price implies a $33 billion valuation for Snowflake. While the company is only eight years old, this IPO valuation makes it bigger than well-established companies such as Travelers. Is it justified for a loss-making company to have a $33 billion valuation? The answer from us is no.
Strong growth is a positive signal for SNOW stocks and it is possible that SNOW will be the next Google or Apple. However, the company is still too young. In a competitive industry, many challenges can harm its future growth and profitability. While we will keep our eyes on SNOW stocks, investing in Snowflake at this moment offers more risk than reward. Considering the risks involved and the company’s financial performance, at $262 a share, SNOW stocks might see some turbulence going forward.
