Recently public cloud data software company Snowflake (NYSE:SNOW) lives in its own weird, super-overvalued world, spurred on by ebullient analysts. I have written several articles about its massively high valuation and predicted it would fall. And so far, that is exactly what has happened, despite Wall Street analysts continuing to promote SNOW stock. Investors should expect SNOW to keep falling.
After Snowflake went public in late Sept. 2020 at $120, the stock later spiked to $390 on Dec. 8. But since then it has drifted down. As of May 4, it was trading at $217.18, down 20.5% year-to-date and off 14.7% in the last six months. Unfortunately, I believe there is still more downside for SNOW stock.
Growth and Valuation Issues
The reason is simple: SNOW stock trades for 59 times analysts’ sales forecast for the year ending Jan. 2022. Right now Snowflake has a $64.58 billion market capitalization. But its revenue is forecast to be just over $1 billion ($1.09 billion) by Jan. 2022.
Granted, this will be 84% higher than last year’s $592 million in revenue. But does that really warrant such a huge price-to-sales (P/S) multiple? After all, 59 times revenue is the kind of multiple that would be high even if this was a price-to-earnings ratio.
But let’s look at what the company is saying. In its latest Q4 earnings release, Snowflake also predicted that its Q1 revenue (ending April 30) would be between $195 to $200 million. That represents a great 92% to 96% year-over-year (YoY) growth rate.
But here lies the problem. Revenue last quarter was $190 million. So if revenue grows to $197.5 million (the midpoint of its forecast), the quarter-over-quarter (QoQ) growth in sales is just 3.95%. So if this sequential growth continues for 5 quarters, next year its YoY growth will be just 16.75% (i.e., (1.0395 ^4)-1 = 0.1675). The point is that slower Q0Q growth eventually feeds into slower YoY growth.
And that will eventually lead to a dramatic deflation in this company’s P/S multiple. Here is an example of what I mean. Analysts now forecast Jan. 2023 sales will be $1.8 billion. This represents a growth of just 65% over the forecast Jan. 2022 estimate of $1.09 billion. This seems wildly over-optimistic given that its QoQ is slowing to just 3.95% in Q1 2021.
So what is SNOW stock really worth?
Where This Leaves SNOW Stock
Let’s say that that we can just forget the slowing QoQ growth and we accept the $1.8 billion revenue forecast for Jan. 2023 revenue. A more reasonable P/S multiple, given the risk that this will not occur, would be 20 times revenue at most.
But just to be generous, and yet still make the point that SNOW stock is overvalued, let’s give it a 30 multiple. Therefore, 30 times $1.8 billion is a $54 billion market cap. That is still 16.4% below today’s market cap of $64.58 billion.
This means that we can say that SNOW stock is worth 16.55% lower than today’s price of $217.18, or $181.56 per share. That means the stock is likely to keep falling.
But watch out. If my math is correct and the QoQ growth rate eventually feeds into slower YoY growth, then the 30 times sales multiple will fall below 20 times.
For example, by 2023 revenue growth could be just 16% over $1.8 billion, or $2.088 billion. If the market puts a 25 times multiple (not 20x as I suspect), the market cap will be $52.2 billion. That is 19.2% below today’s price. It implies a price target of $175.55.
Be careful. Watch Snowflake’s quarterly growth rate. If it starts to decelerate quickly that could lower its price-to-sales multiple quicker than you think.
Analyst estimates, according to TipRanks.com are $287.00 per share. Their target price is lower than a month ago at $293.16. Expect them to continue to lower their target prices.
On the date of publication, Mark R. Hake did not hold a long or short position in any security mentioned in this article.