Cloud Hosting

Snowflake's (SNOW -5.71%) stock surged 18% during after hours trading on Aug. 24 following the release of the company's second-quarter report. The cloud-based data warehousing company's revenue surged 83% year-over-year to $497.2 million, beating analysts' estimates by $29.9 million. But its net loss still widened from $189.7 million to $222.8 million, or $0.70 per share, and missed the consensus forecast by $0.12.

Snowflake's robust revenue growth overshadowed its earnings miss, but is it still a worthwhile investment in this tough market for tech stocks? Let's review three reasons to buy Snowflake -- and three reasons to sell it -- to decide.

Image source: Getty Images.

Snowflake looks attractive because it's growing like a weed, its retention rates are high, and there's plenty of pent-up demand for its services.

Its product revenue, which accounts for most of its top line, surged 106% to $1.14 billion in fiscal 2022, which ended this January. For fiscal 2023, it expects its product revenue to grow another 67%-68%.

Snowflake expects its product revenue to reach $10 billion by fiscal 2029, which implies it can grow at a compound annual growth rate (CAGR) of 36% over the next seven fiscal years. It intends to achieve that goal by expanding its customer base and gaining more high-value customers.

The company ended the second quarter with 6,808 customers, representing 36% growth from a year earlier. Within that total, its number of customers that generated more than $1 million in trailing-12-month product revenue increased 112% to 246. It expects that high-value cohort to expand to about 1,400 customers by fiscal 2029.

Snowflake's long-term goals seem lofty, but the stickiness of its ecosystem supports those ambitions. It ended the second quarter with a net revenue retention rate of 171%, compared to 169% a year earlier. Its remaining performance obligations, or the revenue it expects to recognize from its existing contracts, also surged 78% year-over-year to $2.7 billion.

Snowflake's growth rates are jaw-dropping, but its negative margins, competitive headwinds, and nosebleed valuations offset most of those strengths.

Its net loss widened from $539.1 million in fiscal 2021 to $679.9 million in fiscal 2022. Analysts expect a wider loss of $742 million this year, followed by even steeper losses in fiscal 2024 and fiscal 2025.

On a non-GAAP (generally accepted accounting principles) basis, which excludes its stock-based compensation and other one-time costs, its operating margin came in at negative 3% in fiscal 2022. It expects its non-GAAP operating margin to rise to positive 2% this year, but it still faces a long uphill battle toward generating stable non-GAAP profits.

All that red ink leaves Snowflake exposed to competitive threats. It established an early-mover's advantage in the cloud-based data warehousing market, but its growth has convinced legacy players like Amazon (AMZN -0.73%) Web Services (AWS), Microsoft (MSFT -1.07%) Azure, and Alphabet's (GOOG -0.86%) (GOOGL -0.83%) Google Cloud to upgrade their older data warehousing solutions. All three tech giants are bundling their data warehousing services with their other cloud infrastructure services, but Snowflake actually operates its platform on top of AWS, Azure, and Google Cloud.

Therefore, Snowflake is ironically paying hefty cloud hosting fees to its largest rivals. If push comes to shove, Amazon, Microsoft, and Google could aggressively undercut Snowflake's prices while raising their cloud hosting fees. That pressure could make it impossible for Snowflake to ever turn a profit.

Lastly, Snowflake's stock has plunged more than 50% since it hit its all-time high last November, but it's still expensive. With a market cap of $60 billion, Snowflake trades at nearly 30 times this year's sales. That high valuation -- along with its lack of profits -- makes it a risky stock to own as rising interest rates drive investors away from speculative growth plays.

Snowflake's stock was already expensive when it went public at $120 nearly two years ago, and it's still pricey today. Its business is growing rapidly, but it's hard to tell if it can achieve its ambitious goals for fiscal 2029 without being derailed by its larger competitors. I'd consider buying Snowflake if its stock gets cut in half again, but it's simply too rich and risky for my blood right now.

John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Leo Sun has positions in Alphabet (A shares) and Amazon. The Motley Fool has positions in and recommends Alphabet (A shares), Alphabet (C shares), Amazon, Microsoft, and Snowflake Inc. The Motley Fool has a disclosure policy.

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3 Reasons to Buy Snowflake Stock, and 3 Reasons to Sell - The Motley Fool