Shares of Snowflake (SNOW 0.15%) have underperformed the broader stock market in 2023, which seems a tad surprising given the company’s impressive growth as well as a solid rally in technology stocks this year.
The cloud-based data platform provider has appreciated just 14% this year. For comparison, the tech-laden Nasdaq-100 Technology Sector index has jumped 38% in 2023. Snowflake’s results for the second quarter of fiscal 2024 (for the three months ended July 31, 2023), which were released on Aug. 23, couldn’t improve investors’ sentiment despite a solid set of numbers.
Snowflake stock fell 5% after the report. But this could be an opportunity for savvy investors to buy a fast-growing company that’s sitting on a massive addressable market. Let’s look at why buying this cloud stock could turn out to be a smart long-term move.
Snowflake’s impressive growth is here to stay
Fiscal second-quarter revenue was $674 million, a 36% jump year over year. Adjusted earnings jumped sharply to $0.22 per share from $0.01 in the year-ago period. The numbers were well ahead of consensus estimates, as analysts were anticipating $0.10 per share in earnings on revenue of $662 million.
Snowflake’s explosive performance last quarter can be attributed to the robust growth in the company’s customer base, as well as an increase in customer spending. The company exited the quarter with just over 8,500 customers, an increase of 25% over the prior-year period. The number of customers that have spent more than $1 million in the past year increased at a faster pace of 62% to 402 last quarter.
This explains why Snowflake’s future-revenue pipeline improved nicely last quarter, as evident from the 30% year-over-year increase in its remaining performance obligations (RPO) to $3.5 billion. This metric refers to the amount of contracted future revenue that hasn’t been recognized by the company yet. It said that 57% of its RPO is expected to be recognized as revenue within the next 12 months. That translates into just over $2 billion, or a quarterly revenue run rate of $500 million.
Given that the company has generated $1.3 billion in revenue in the first six months of fiscal 2024, it is well on its way to hitting its product revenue target of $2.6 billion for this current fiscal year. That would be a 34% increase over the previous year.
Wall Street, however, was anticipating $2.76 billion in full-year revenue. But Snowflake is witnessing weakness due to macroeconomic challenges that have led some of its customers to pull back on spending, which explains why its guidance has fallen slightly behind Wall Street’s expectations.
But the good part is that Snowflake is witnessing an improvement in its end market. Chief financial officer Mike Scarpelli said on the latest earnings conference call:
Consumption came in line with their expectations for the quarter. In May, we saw a return to growth with strength continuing into June and July. From a booking standpoint, we saw promising signs of stabilization with new bookings outperforming our expectations.
So, it won’t be surprising to see Snowflake delivering better-than-expected growth. More importantly, the company is expected to sustain healthy growth as the following chart suggests.
Although the two lines on the chart appear flat, it’s important to remember that the comparison here is between two different fiscal years. The purple line shows Snowflake’s estimated revenue in fiscal year 2025, while the orange line shows the projected revenue in fiscal year 2026. The amount for fiscal year 2026 (the orange line) is greater than that of 2025’s projection (the purple line), demonstrating its growth potential.
What’s more, the company estimates that it could quadruple its revenue in the next five years. It has set an annual revenue target of $10 billion for fiscal 2029, which means that it needs to increase it at a compound annual growth rate of 30% for the next five years. Given that Snowflake is sitting on a total addressable market worth $140 billion, which is expected to jump to $290 billion in 2027, there is ample opportunity for the company to maintain solid growth in the long run.
Why the stock seems worth buying right now
Snowflake now trades at an expensive 20 times sales. But the stock’s price-to-sales (P/S) ratio has come down significantly over the past year despite a solid increase in revenue.
Buying Snowflake at this valuation could turn out to be a smart move for investors looking to buy a growth stock, considering the potential revenue increase it is expected to deliver. Assuming it does hit $10 billion in revenue after five years and trades at a relatively lower 15 times sales, its market cap could hit $150 billion. That would be more than triple the company’s current market cap of $48 billion.
Even if the sales multiple falls to 10 after five years and its revenue increases to $10 billion in fiscal 2029, the market cap would increase to $100 billion, indicating that investors would do well to buy Snowflake stock while it is still down because it could turn out to be a long-term winner.
Harsh Chauhan has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Snowflake. The Motley Fool has a disclosure policy.