Cloud computing company Snowflake (NYSE:SNOW) is one of a bumper crop of highly anticipated initial public offerings (IPOs), but investors who missed out on the initial post-IPO ebullience should wait for more retrenchment in the stock before jumping in.
Much of that initial hoopla was derived via two factors: SNOW’s status as a cloud stock and Berkshire Hathaway (NYSE:BRK.B) backing the company. While Warren Buffett’s conglomerate warmed to technology stocks in recent years, Snowflake isn’t the typical Berkshire equity holding. Buffett is a famed value investor. Snowflake currently trades at 154x sales, the antithesis of a value name.
Rich valuations don’t mean a stock is doomed to extensive pullbacks or failure. History is littered with examples of market participants bidding up pricey growth stocks, making those names more expensive in the process. However, analysts and high-level investors often more closely scrutinize rich valuations on newer companies like Snowflake.
Just a handful of analysts cover the stock, most with tepid “hold” ratings or equivalent grades citing rich multiples.
With Time, SNOW Stock Can Allay Concerns
At the height of its post-IPO bliss, SNOW had a brief flirtation with a market capitalization of $90 billion. Trouble was that’s well in excess of the $81 billion total addressable market (TMA) the company forecast in a pre-IPO filing. In other words, Snowflake is still expensive relative to that TMA with market value of around $72 billion as of Oct. 6. The good news is that TMA can expand.
“The company provides a best-of-breed cloud-based data warehouse, serving a ~$20 billion market growing double digits,” said Bernstein analyst Zane Chrane in a recent client note. “Snowflake is taking share from on-prem vendors, competing successfully against cloud giants for new workloads, and expanding the TAM [total addressable market] by offering a differentiated platform that’s easier to develop/manage, higher performing, with more transparent pricing.”
Snowflake has another enviable feather in its cap: An impressive retention. At 158% at the time of its IPO, Snowflake’s client retention rate was the highest of any publicly trade cloud computing company, easily topping the likes of CrowdStrike (NASDAQ:CRWD), Datadog (NASDAQ:DDOG) and ZoomInfo (NASDAQ:ZI), just to name a few.
Additionally, the aforementioned valuation issues aren’t scaring off some big-name investors. For example, Dan Loeb’s Third Point hedge fund recently took a stake in the cloud company. This is relevant because Loeb has a lengthy track record of success with growth and technology stocks and his investment vehicle currently holds stakes in several cloud names.
Patience Could Be Rewarded
It’s tempting to jump into the shiny new object, particularly when that object resides in the scintillating cloud computing space, but investors would do well to exercise discretion with Snowflake.
With time, Snowflake can either expand its TMA, markets can reconcile the lofty multiples following a deeper pullback, or both. Each of those scenarios are important because Snowflake is far more expensive than rivals such as Datadog. In the hear and now, the sell-side community is piling on the valuation thesis and that’s a legitimate headwind for Snowflake.
Looking further out to December, Snowflake staffers will get their first chance to sell up 25% of the stock they own. That means a spate of selling is coming with some analysts forecasting as many as 50 million shares worth of new supply coming to market.
Bottom line: Interested investors would do well to sit on their hands with Snowflake and wait for the lockup selling to pass. Then put the stock on their post-holiday shopping lists because potential three-year upside with this name is considerable.
On the date of publication, Todd Shriber did not have (either directly or indirectly) any positions in any of the securities mentioned in this article.
Todd Shriber has been an InvestorPlace contributor since 2014.
