Is SNOW Overvalued After Today's Rally?

Software company Snowflake stunned Wall Street today as it surged to $172.47, marking a 2.9% change compared to the S&P 500 and the Nasdaq indices, which logged 0.7% and 0.2% respectively. SNOW is -21.58% below its average analyst target price of $219.94, which implies there is more upside for the stock.

As such, the average analyst rates it at buy. Over the last year, Snowflake has underperfomed the S&P 500 by 32.1%, moving -50.7%.

Snowflake Inc. provides a cloud-based data platform in the United States and internationally. The companyis in the technology sector, which groups together a wide range of industries including consumer electronics, software, computer hardware, scientific instruments and IT services. Legendary investor Warren Buffet once stated that he would never invest in technology companies. Apple is now one of his largest holdings.

The risks inherent to the technology sector are clear, but investors simply cannot ignore the potential for strong returns. Even with the lessons learnt in the 2000 tech bubble, the market continues to highly value the promise of technological innovation and the ability for these companies to build and occupy new markets.

Snowflake does not release its trailing 12 month P/E ratio since its earnings per share of $-2.1 were negative over the last year. But we can calculate it ourselves, which gives us a trailing P/E ratio for SNOW of -82.1. Based on the company's positive earnings guidance of $0.44, the stock has a forward P/E ratio of 392.0.

As of the third quarter of 2022, the average Price to Earnings (P/E) ratio of US technology companies is 26.5, and the S&P 500 average is 15.97. The P/E ratio consists in the stock's share price divided by its earnings per share (Eps), representing how much investors are willing to spend for each dollar of the company's earnings. Earnings are the company's revenues minus the cost of goods sold, overhead, and taxes.

Snowflake's P/E ratio tells us how much investors are willing to pay for each dollar of the company's earnings. The problem with this metric is that it doesn't take into account the expected growth in earnings of the stock. Sometimes elevated P/E ratios can be justified by equally elevated growth expectations.

We can solve this inconsistency by dividing the company's trailing P/E ratio by its five year earnings growth estimate, which in this case gives us a 3.33 Price to Earnings Growth (PEG) ratio. Since the PEG ratio is greater than 1, the company's lofty valuation is not completely justified by its growth levels.

An analysis of the company's gross profit margins can help us understand its long term profitability and market position. Gross profits are the company's revenue minus the cost of goods only, and unlike earnings, don't take into account taxes and overhead. Here's an overview of Snowflake's gross profit margin trends:

  • 2021 gross margins: 62.4 %
  • 2020 gross margins: 59.0 %
  • 2019 gross margins: 56.0 %
  • 2018 gross margins: 46.5 %
  • Average gross margin: 56.0 %
  • Average gross margin growth rate: 10.5 %
  • Coefficient of variability (lower numbers indicating more stability): 12.3 %

We can see from the above that Snowflake's gross margins are very strong. Potential investors in the stock will want to determine what factors, if any, could derail this attractive growth story.

Snowflake's financial viability can also be assessed through a review of its free cash flow trends. Free cash flow refers to its operating cash flows minues its capital expenditures, which are expenses related to the maintenance of fixed assets such as land, infrastructure, and equipment. Over the last four years, the trends have been as follows:

  • 2021 free cash flow: $93,958,000.00
  • 2020 free cash flow: $-80,454,000.00
  • 2019 free cash flow: $-195,141,000.00
  • 2018 free cash flow: $-146,040,000.00
  • Average free cash flow: $-81,919,250.00
  • Average free cash flown growth rate: 80.6 %
  • Coefficient of variability (lower numbers indicating more stability): 154.2 %

Free cash flows represents the amount of money that is available for reinvesting in the business, or paying out to investors in the form of a dividend. With a positive cash flow as of the last fiscal year, SNOW is in a position to do either -- which can encourage more investors to place their capital in the company.

Another valuation metric for analyzing a stock is its Price to Book (P/B) Ratio, which consists in its share price divided by its book value per share. The book value refers to the present liquidation value of the company, as if it sold all of its assets and paid off all debts. As of the third quarter of 2022, the average P/B ratio for technology companies is 5.57. In contrast, the average P/B ratio of the S&P 500 is 2.95. Snowflake's P/B ratio indicates that the market value of the company exceeds its book value by a factor of 10.2, so it's likely that equity investors are over-valuing the company's assets.

Since it has a negative P/E ratio, an elevated P/B ratio, an irregular stream of negative cash flows on an upwards trend, Snowflake is likely overvalued at today's prices. The company has mixed growth indicators because of an inflated PEG ratio and consistently strong gross margins that are increasing. We hope you enjoyed this basic overview of SNOW's fundamentals. Make sure to check the numbers for yourself, especially focusing on their trends over the last few years.

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The above analysis is intended for educational purposes only and was performed on the basis of publicly available data. It is not to be construed as a recommendation to buy or sell any security. Any buy, sell, or other recommendations mentioned in the article are direct quotations of consensus recommendations from the analysts covering the stock, and do not represent the opinions of Market Inference or its writers. Past performance, accounting data, and inferences about market position and corporate valuation are not reliable indicators of future price movements. Market Inference does not provide financial advice. Investors should conduct their own review and analysis of any company of interest before making an investment decision.