Should you dive into Snowflake (NYSE:SNOW) stock after its recent dip? With this tech IPOs this year, I know it’s tempting to want to buy in now, in anticipation of a bounce back. But, there’s good reason why this “too hot to touch” stock may not be so hot.
What do I mean? Not only is the stock’s frothy valuation a reason for concern. The company’s competitive advantage may not be as great as investors currently believe. A lot are buying into this name thinking it’ll be for cloud data warehousing what Shopify (NYSE:SHOP) was for e-commerce. But, while that company carved out a niche for itself in a space dominated by names like Amazon (NASDAQ:AMZN), lightning may not strike twice.
Sure, as “growth at any price” remains the mantra on Wall Street, tech stock valuations have yet to contract. And, while there’s room to be worried Snowflake fails to outfox its deep-pocketed competitors, it’s growth train is far from falling off the rails.
Either situation could be on the horizon. This may not impact shares in the near term. But, for a long-term position, it still pays to wait-and-see with this newly-minted tech darling.
Breaking Down SNOW Stock
What’s the rationale for buying Snowflake today, while shares trade at an ultra-premium valuation? The prospects of this rising star continuing to “crush it” in the growth department.
Granted, with revenue expected to soar from $571.4 million in FY21 (ending Jan 2021), to $1.07 billion in FY22 (ending Jan 2022), there’s plenty to back up its growth story. Yet, as I discussed earlier this month, even for tech growth stocks Snowflake’s valuation is a tad rich.
Sure, you can argue that with the acceleration in demand for cloud-based data analytics and warehousing, the situation is more a slam-dunk than with other story stocks.
But, it’s not like Snowflake has the franchise on this emerging industry. And, given its rivals include some of the biggest tech names, who’s to say this company will have the edge? While being a newcomer isn’t that much of a handicap in this sector (just look at Amazon’s rise to the top of the heap), the situation for this company may turn out different. And, not in a good way.
Competition Is the Larger Concern
A rich multiple may be why analysts like Bernstein’s Zane Chrane have rated SNOW stock a “hold.” But, the larger concern may be competition, not valuation. What do I mean? As our own Josh Enomoto wrote on Oct. 7, this company stands the risk of winding up like another once-hot cloud play, Cloudera (NYSE:CLDR).
How so? As Enomoto discussed, that company lost its edge due to competition from Amazon and Microsoft (NASDAQ:MSFT). The same could happen with Snowflake.
Here is a prime example of why this company is vulnerable to its larger rivals. Not only is Snowflake a competitor to Amazon; it’s a customer as well. The tech giant’s AWS unit is the company’s biggest vendor. Sure, the company is looking to diversify who provides its cloud infrastructure. But, these alternatives are competitors like Microsoft and Alphabet (NASDAQ:GOOG, NASDAQ:GOOGL).
Sure, given we are still in a tech stock bubble, it’s no surprise investors have largely ignored this competitive risk. But, what’s going to happen once those trading on FOMO and momentum leave the room, and fundamentals become top of mind once again? Wall Street may start factoring in these risks into its share price.
Sure, I could be missing the forest for the trees. Snowflake could have a shot at outfoxing the tech powerhouses in this fast-growing industry. Yet, today’s valuation prices this in as a certainty, not as a possibility.
In short, “priced for perfection” is an understatement with SNOW stock. With this in mind, shares could take a big tumble if things fall short of expectations. With this in mind, buying now, while shares remain hot, doesn’t look like the best move.
Keep on Waiting for a Better Entry Point
The specter of competition from Alphabet, Amazon, and Microsoft may not hurt Snowflake in the short run. Its rapid growth could continue over the next few quarters. But, the long-term prospects remain murky. That’s not to say the company’s top line will quickly top out. However, growth could cool as the tech giants get more aggressive for market share in this industry.
So, what does that mean for those interested in SNOW stock? We haven’t reached a favorable entry point just yet. Sit things out for now, and wait for additional pullbacks before diving into shares.
On the date of publication, Thomas Niel did not (either directly or indirectly) hold any positions in the securities mentioned in this article.
Thomas Niel, contributor to InvestorPlace, has written single stock analysis since 2016.
