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Palantir Technologies has been a big winner over the past year and a half. Shares are up more than 300% since the start of 2023. The data software company appears to have a bright future, but it’s hard to deny that the opportunities for new investors to profit after such a run have diminished. However, there is another data software company lurking in the shadows of Wall Street, waiting to shine.
Snowflake‘S (NYSE: SNOW) The initial public offering (IPO) was one of the most hyped in recent history, but the stock has disappointed. The shares have lost a quarter of their value over the past year and are almost 70% below their 2021 highs.
That said, much of the stock’s problems stem from circumstance, and it still possesses some of the qualities that made Wall Street so excited about its IPO in the first place.
The hype got out of hand.
Data forms the basis for modern technology companies. Whether a company is trying to train a complex AI model or understand what its customers want, data is the crucial piece of the puzzle. Meanwhile, companies are steadily migrating their digital operations from on-premise systems to cloud-based systems, and migrating data to the cloud is a natural part of that.
Snowflake IPO generated a lot of hype for its innovative core product, a data warehousing platform that allows customers to securely store and retrieve their data in the cloud. Snowflake is cross-platform and compatible with all major cloud infrastructure providers (Amazon Web services, Microsoft Azure and Google Cloud), which gives its customers flexibility instead of tying them to a specific cloud vendor. In fiscal 2022 (which ended January 31, 2022), Snowflake’s revenues increased 106% to $1.1 billion.
Even the great Warren Buffett, who is known for his strict valuations and generally avoids technology stocks, bought a stake in Snowflake at the IPO. Berkshire Hathaway.
Snowflake went public in the summer of 2021, perhaps the height of the euphoria for growth stocks. The Fed’s ultra-low interest rate policies at the time drove the valuations of many stocks to bubble-like levels, and Snowflake was one of them. At its peak, Snowflake traded with an enterprise value-to-sales ratio of over 215.
Do you think AI-driven excitement? created a bubble in Nvidia stock this year? By comparison, Nvidia’s enterprise value-to-sales ratio peaked at just 45. That should underscore how ridiculous Snowflake’s valuation had become. The stock was almost certainly doomed to a painful fall back to Earth no matter what the company did.
Some self-inflicted wounds
The underlying business has not been perfect. Snowflake was not immune to the impact of higher interest rates on the technology sector. Snowflake’s billing is usage-based, and macroeconomic conditions and fears are putting enough pressure on customer spending to drag the company’s net revenue retention from 178% in the fourth quarter of fiscal 2022 to 128% in the first quarter of 2025.
Overall revenue growth slowed from a triple-digit percentage to just over 30% in the most recently reported quarter.
That doesn’t look good when the company’s biggest competitor, a privately held company called Data Bricks, recently announced that it is on track for annualized revenue of $2.4 billion on 60% growth. Have higher interest rates affected Snowflake’s growth? Certainly, but competition is causing problems, and that is perhaps more worrying.
Buy and hold a snowflake? This is why
So why buy the stock in light of all this? It comes down to some simple facts.
First, Snowflake is ready to respond to competitive pressure. Data Bricks credits AI-related demand for its growth momentum. Snowflake promoted its vice president of AI, Sridhar Ramaswamy, to CEO after Frank Slootman retired earlier this year. Time will tell how Ramaswamy performs in this role, but having leadership that tends to focus on AI should be a good thing.
Second, Snowflake’s growth rate should stabilize and possibly improve. The remaining performance obligation – activities that have been booked but for which no revenue has yet been recognized – has increased significantly over the past two quarters.
And looking at the bigger picture, the data is growing exponentially, which builds natural growth into Snowflake’s business model as customers will need to store and retrieve more data over time.
Third, the stock’s valuation is more forgiving than it was years ago. Today, Snowflake trades at a forward enterprise value-to-sales ratio of just over 11. That’s a fraction of what it once was — and about half of what Wall Street, dear Palantir, is trading at. In other words, Snowflake has gone from an obnoxiously expensive favorite to an underdog in the bargain bin.
Snowflake is poised to grow in the coming years, especially if the new CEO can position the company to become more successful in the AI space. Because the valuation is at a reasonable (arguably cheap) level, investors who buy now can enjoy excellent returns.
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Justin Pope has no position in any of the stocks mentioned. The Motley Fool holds positions in and recommends Berkshire Hathaway, Palantir Technologies, and Snowflake. The Motley Fool has one disclosure policy.
Missed Palantir’s run-up? Here are my top alternative data software stocks to buy and hold was originally published by The Motley Fool