Is Snowflake a good buy for 2022?

Winter may have arrived, but the data warehouse provider Snowflake (NYSE: SNOW) remains a burning name on Wall Street. Snowflake, which boasts Salesforce.com and Warren Buffet’s Berkshire Hathaway as investors, went public in September 2020 and recorded the largest software IPO in history. Since its IPO, revenue growth has exploded and Snowflake’s market cap has climbed 41% to $ 99 billion. As growth stocks continue to battle market volatility, let’s dig in and see if Snowflake is a good buy as the New Year dawns.

Data is the new oil

Snowflake provides cloud-based data warehouse solutions to large enterprises such as A capital letter, Anthem, and Twilio. The impacts of the COVID-19 pandemic have underscored the importance for businesses to adopt flexible cloud computing solutions. Data warehouses are an essential component of systems management by providing short-term stability within an enterprise, while also adapting for the long term as organizations collect, store and analyze more data.

According to Research And Markets, the global data warehouse as a service market is expected to grow at a compound annual growth rate of 22% and reach $ 13 billion by 2026. Additionally, Snowflake’s latest investor presentation suggests that its total addressable market, capturing both data warehousing and cloud data platforms, is $ 90 billion. Snowflake has benefited from a large and growing addressable market and its financial results prove it.

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Robust financial profile or market euphoria?

For the fiscal quarter ended October 31, 2021, the company had more than 5,400 customers and 173% net income retention. Perhaps even more impressive is that Snowflake’s revenue of $ 334.4 million represents 110% year-over-year growth. Additionally, the company’s forecast for total revenue in 2021 was $ 1.1 billion, up 103% from the 2020 schedule.

While its large addressable market provides Snowflake with a new opportunity, it also allows new competitors to enter the market. As businesses invest in digital transformation, Snowflake has doubled its product development and marketing efforts to beat the competition. For the nine months ended October 31, 2021, Snowflake’s selling and marketing costs were $ 540.7 million, or 65% of total revenue and a 66% increase over the same period in 2020. In addition, research and development expenses amounted to $ 343.8 million, representing 41% of total revenue and an increase of 139% year-over-year.

Investors could argue that these investments generated more than triple-digit revenue growth. However, the company’s financial statements show that as income increases, so does its losses. Although the company generated total revenue of $ 835.6 million in the first nine months of 2021, Snowflake spent more than $ 1.0 billion in operating expenses, resulting in a loss of operation of $ 563 million. What could be even more concerning is that this loss is significantly higher than at the same time of the previous year, when the loss was $ 343.5 million. Although it remained in the red, the stock still rose 20% in 2021 and as of this writing, it is trading at 107 times its turnover in the past 12 months.

Is the valuation premium justified?

At first glance, it may appear that there is a mismatch between the underlying fundamentals of Snowflake and its valuation. Perhaps investors view current investments as a short-term sacrifice on profitability in order to achieve management’s long-term vision of $ 10 billion in annual product revenue.

Despite this, with a market capitalization hovering around $ 100 billion, it is reasonable for investors to exercise some caution when considering investing in Snowflake. For context, public competitors such as Datadog (NASDAQ: DDOG) and C3.ai (NYSE: IA) trade 60 times and 17 times the income of the last 12 months, respectively. .

Despite the recent compression in valuation multiples, especially in high growth software stocks, Snowflake still appears to be trading at a premium relative to some of its peers. Additionally, the company’s aggressive spending on product development and marketing may need to be adjusted as we head into a year of rate hikes.

All eyes on the Federal Reserve

The Federal Reserve recently announced that it will start cutting back on its bond buying activity and that 2022 will see at least three interest rate hikes. A rising interest rate environment means that the cost of borrowing money will become more expensive for businesses.

For growth companies like Snowflake, this dynamic could have a significant impact on free cash flow. While the exact timing of these rate hikes will vary, investors already know that Snowflake is currently operating at a loss and that the rate hike could hurt its ability to invest aggressively and to follow its growth roadmap.

Now what?

Snowflake is expected to release its fiscal fourth quarter and fiscal 2021 results in March. At this point, investors should know how close the company is to its earlier forecast, and perhaps more importantly, what it expects for 2022 in terms of revenue growth and operating profits. .

While the company’s future prospects are bright given its growing addressable market and triple-digit revenue growth, the company continues to operate at a loss. With interest rate hikes on the horizon, it may be more prudent for investors to assess the performance of Snowflake stock once the Federal Reserve institutes its new policies before initiating or adding. to an existing position in 2022.

This article represents the opinion of the author, who may disagree with the “official” recommendation position of a premium Motley Fool consulting service. We are motley! Challenging an investment thesis – even one of our own – helps us all to think critically about investing and make decisions that help us become smarter, happier, and richer.