Want to learn how to 5X, 10X, even 20X your stock gains?

Join investing legend Louis Navellier on March 3 when he unveils his most aggressive — and most exciting — way to play the boom in tech stocks.

Wed, March 3 at 4:00PM ET

What to Do If You Missed out on the Snowflake Stock IPO

When Snowflake (NYSE:SNOW) popped 112% the day of the SNOW IPO, outside investors watched in envy as corporate insiders reaped instant profits. When the dust settled, those lucky enough to receive Snowflake’s initial $120-per-share allocation walked away with a combined $3.8 billion in profits.

Snowflake IPO on the NYSE
Source: rblfmr / Shutterstock.com

So, what should regular investors now do about SNOW stock?

History offers a sobering lesson. Despite a strong temptation to jump in, history says it will pay to wait. And here’s why.

A Waiting Game

Decades of data show that new issues tend to underperform the market. In a study of IPOs from 1980-2018, University of Florida professor Jay Ritter found that IPOs of unprofitable companies like Snowflake average a -25.9% in market-adjusted returns over the following three years.

Why? First, investors often become smitten with the “lottery” effect, rushing to buy unprofitable companies in hopes of finding the next billion-dollar winner. Second, a stock’s first-day pop often reflects an inadequate supply. These stocks often give up initial one-day gains as more shares become available. (In the same study, Ritter found that IPOs pop 25.6% on the first trading day.)

Even buying great companies at the wrong price still makes a bad investment. Amazon (NASDAQ:AMZN) shares cratered 93% during the 2000 tech bubble burst as investors questioned when (or if) the e-commerce company would ever turn a profit.

But for those unsatisfied with generalizations of the IPO market, here’s a deeper dive into why it will pay to wait on Snowflake’s valuation.

SNOW IPO: Growing Market, but Tough Competition

At its core, Snowflake offers data warehousing and computing power. In other words, companies can use the firm to upload data and rent on-demand servers to crunch the information. The process gives data scientists enormous computing power when needed and scales it back at other times to reduce costs.

These offerings, however, aren’t unique. Microsoft (NASDAQ:MSFT) Azure Synapse and Amazon Redshift, among others, all do the same thing. Prices are also comparable – a benchmark by Fivetran, a data integration company, found just a 30% cost difference between the top four industry players and virtually identical performance on benchmark tests.

“These warehouses all have excellent price and performance,” Fivetran reported. “We shouldn’t be surprised that they are similar: The basic techniques for making a fast columnar data warehouse have been well-known since the C-Store paper was published in 2005.”

That statement should make any tech investor stop dead in their tracks. I’ve covered many high-growth tech companies, and the best always have some world-beating product or marketing (think of the Apple (NASDAQ:AAPL) iPhone or Tesla (NASDAQ:TSLA) Model S). But at first glance, there’s no apparent reason why Snowflake should have “instantly becoming one of the stock market’s most expensive stocks,” as Barrons associate editor Eric Savitz wrote.

So, why are investors going wild over Snowflake?

Only One Snowflake

Squint hard enough, and some reasons begin to emerge.

Firstly, there’s cheap financing. Snowflake has some big-name backers, including Berkshire Hathaway (NYSE:BRK.A NYSE:BRK.B) and Salesforce (NYSE:CRM), making it easy to raise capital. The “Warren Buffett effect” is hard to overstate; Snowflake now trades at 250x trailing revenues. That means the company could theoretically cover its entire 2019 cash burn of $177 million by issuing just 0.26% of new shares. (Even Amazon traded at “just” 35x trailing revenues at its peak in 1999.)

Secondly, Snowflake remains a “pure-play” shop, offering a more focused set of tools than Microsoft or Amazon. That works well for businesses that prefer to keep data analytics separate from other IT functions. More importantly, however, Snowflake’s hyper-focus on BI makes it a tempting takeover target for other IT companies. Oracle (NYSE:ORCL) stands out as a top contender – it’s a relative late-comer to cloud computing and desperately needs to catch up.

Third, Snowflake has an eerily aggressive salesforce. In fiscal 2020, the company spent almost three times as much on sales and marketing than on R&D, or 50% more than rival Cloudera (NYSE:CLDR) typically does.

“It was Snowflake’s ability to scale Marketing and Sales to meet aggressive growth goals,” wrote Brandon Redlinger, director of growth at Engagio, “that gave them the leverage they needed to secure funding for additional growth and globalization.”

But these three reasons aren’t good enough to justify the value of “the most expensive name in all tech,” as Summit Insights analyst Srini Nandury puts it. Even with its massive sales growth, Snowflake still trades at 76x sales, versus 41x for Zoom Video (NASDAQ:ZM) or 31x for Shopify (NYSE:SHOP).

So, despite its great underlying business and outlook, shares are too richly valued.

What’s Snowflake Stock Worth?

The cloud computing industry will likely have multiple winners – the technology doesn’t benefit from the same network effects that e-commerce or ERP systems have. That makes Snowflake slightly easier to value since it’s not all-or-nothing. But that doesn’t mean it’s a walk in the park.

If the company can grow its revenues to $27 billion and achieve a 36% EBIT margin by 2030 (roughly 70% the size of Oracle today), its fair value comes to $240 per share. That’s certainly not impossible for a fast-growing company like Snowflake.

If the company stumbles, however, its share value will plummet. Suppose the company only grows to $15 billion revenue by 2030 (that’s still a 50% CAGR) and maintain the same EBIT margin. In that case, its fair value drops to just $130 per share, or close to its original offer price.

What’s Next for Snowflake?

Will Snowflake justify its hyper-premium valuation? Possibly. Hundreds of tech companies have succeeded in overturning those before it. (Consider how Apple trounced Nokia (NYSE:NOK) in smartphones.) And the company sits in a rapidly expanding field. Gartner, a research firm, estimates worldwide spending on cloud computing to rise 33% to $354 billion by 2022. Snowflake could become the next Oracle if it plays its cards flawlessly.

But should you take that bet? Given what history tells us, it’s better to wait. Even if you’re missing out on the next Oracle, history isn’t on Snowflake’s side.

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

Tom Yeung, CFA, is a registered investment advisor on a mission to bring simplicity to the world of investing.

Article printed from InvestorPlace Media, https://investorplace.com/2020/09/what-to-do-if-you-missed-out-on-the-snow-ipo/.

©2021 InvestorPlace Media, LLC