Snowflake Needs to Come Back to Earth Before It’s a Buy

Snowflake (NYSE:SNOW) stock soared in its Wall Street debut, bringing the cloud data company’s market cap to $70 billion and making the Snowflake IPO the largest software IPO ever.

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Naturally, such a hugely successful IPO has caught the attention of retail investors, and now the whole world is asking: is SNOW stock a buy?

The answer is pretty simple.

No.

Snowflake is a great company. A world-changing company, at that. But after more than doubling from its IPO price, SNOW stock has surged into wildly overvalued territory. This “new company” hype will fade. As it does, SNOW stock will drop and settle into a more tangible valuation.

So don’t chase SNOW stock here. Instead, let the IPO fire cool off. Let the stock drop. Start looking to buy the dip in Snowflake stock around $180.

Here’s a deeper look.

Snowflake is a Great Company

I cannot emphasize this enough. The reason the Snowflake IPO was such a huge success is because Snowflake is a great, great company.

Snowflake has essentially created an all-in-one digital data hub – what management dubs the “Data Cloud” – which seamlessly unifies and integrates data across all data types, business functions, teams and even organizations.

Snowflake’s Data Cloud platform represents the future of data management. At present, data silos and strict governance limit the usefulness and transfer-ability of data. The Data Cloud eliminates those silos and governance restrictions, and puts all data – regardless of source or type – into one centralized location, so that it can be used by anyone, for any purpose.

As more and more companies migrate to the cloud and lean into data-driven decision making to create competitive advantages, more and more companies will adopt Snowflake’s Data Cloud as the data management backbone in this process.

And, because we are entering a world wherein data-driven decision making will become ubiquitous across the enterprise, Snowflake has an opportunity to also become ubiquitous across the enterprise.

The company has just 3,117 customers today. There are tens of thousands of companies in the U.S. alone that make more than $1 million in revenue. Clearly, the go-forward growth opportunity here is enormous.

Profit margins are juicy at 60%-plus gross margins and climbing. Net revenue rates are huge at 148%. Business momentum has sustained amid the pandemic, and 2020 revenue is up more than 130%.

In other words, Snowflake checks off all the boxes. This is a long-term winner.

Snowflake Stock Is Overvalued

Although Snowflake is a long-term winner, SNOW stock today is overvalued.

Let’s make some aggressive assumptions about the company’s long-term growth prospects (which, by the way, is totally reasonable to do given the company’s strong business fundamentals and enormous market tailwinds).

Total customers today sit around 3,000. Let’s say that grows to 50,000 by 2030 as more companies adopt data-driven decision making practices. Average annual contract value today hovers around $110,000. Let’s say that grows to $200,000 as existing and new customers expand data usage across their enterprise.

Gross margins are around 60% today. Let’s say that expands to 70%-plus due to volume buy discounting of storage space from cloud data-center giants. Operating profits are in the red today. Let’s say operating margins rise to ~30% by 2030, thanks to economies of scale.

Those are some pretty aggressive long-term growth assumptions. Under them, my modeling suggests that Snowflake will be a $10-plus billion revenue and ~$3 billion net profit company by 2030.

Application software stocks typically fetch a 35 times forward earnings multiple. That sector-average multiple on $3 billion in 2030 projected net profit implies a 2029 valuation target of $105 billion. Discounted back by 8.5% per year, that implies a 2020 valuation target of ~$50 billion – which, based on the current fully diluted share count of 277 million, equates to SNOW stock price of around $180.

Snowflake IPO Hype Will Fizzle Out

Don’t be surprised that SNOW stock is wildly overvalued today.

It’s not uncommon for freshly public, hyper-growth stocks to shoot into overvalued territory as soon as they go public. They’re like shiny, new cars that everyone wants to buy.

See Beyond Meat (NASDAQ:BYND) in 2019. Or Spotify (NYSE:SPOT) in 2018. Or Snap (NYSE:SNAP) in 2017.

History is littered with great companies that simply debuted on Wall Street at overvalued price tags. All of them popped into overvalued territory, then dropped into fairly valued territory, then rebounded on the back of powerful long-term growth tailwinds.

SNOW stock will follow in the same trajectory.

We got the the pop into overvalued territory. Now comes the normalization into fairly valued territory. Then the rebound.

Buy on the dip. Not now. Wait for more air to come out. Look to buy around $180.

Bottom Line on SNOW Stock

SNOW stock is a long-term winner. But price matters. And right now, the price on SNOW stock is too high.

Let the IPO hype fade. Buy the dip around $180. Hold for the long haul.

On the date of publication, Luke Lango did not have (either directly or indirectly) any positions in the securities mentioned in this article. 

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Article printed from InvestorPlace Media, https://investorplace.com/2020/09/snowflake-stock-needs-to-come-back-to-earth-before-its-a-buy/.

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