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Tech stocks have been through the wringer this year, to say the least. If you've owned some throughout the year, you probably have a few more gray hairs than you did at the start of 2021. However, the rebound we've seen out of the May low has been extraordinary for the leaders, and that's particularly true for software stocks.
I last covered relative newcomer Snowflake (NYSE:SNOW) back in March, and at the time, the stock had been on a months-long downtrend, being relentlessly pounded by the bears. However, I thought at the time the stock looked good enough to buy, and I stamped a "very bullish" rating on it. Shares subsequently made a moderately lower low, but since then, shares are up 29%.
Source: Seeking Alpha
We'll call that one a win, but the question is, what do we do now? As it turns out, even though the stock is up 29% since my last bullish call, I think the current setup is excellent if you're bullish. Let's start with a look at the daily chart, which to my eyes, shows a fantastic pullback from which the stock can - and I believe will - rally from.
Source: StockCharts
First up, I've annotated the $328 level, which is where Snowflake has run into issues three times now. The first was in January, then again in February, and once again a couple of weeks ago. It is not a coincidence the current rally from the May low failed at $328; that's big price resistance. If you look just below that event, I've also circled the massive volume we saw when the stock failed to break through that resistance, meaning there were a lot of sellers at that level. That's going to be a headwind when Snowflake gets back there, so I wouldn't expect the stock to just blast through $328; there's a lot to work through so it may take an extra try or two.
However, literally everything else about Snowflake's current setup looks quite bullish. First, the accumulation/distribution line is on fire, soaring since the May low. That's exactly what you want to see because it means more often than not, dip-buyers are out in force.
In addition, the PPO is returning to centerline support at the same time that the stock has just bounced off of its 50-day moving average. When support levels coincide like that, you have to lick your chops because it is as though the stars are aligning. None of this guarantees a bounce, but I'm certainly not willing to bet against that being the case.
Now, let's take a look at relative strength, with the stock against its peer group on top and the peer group against the S&P 500 on the bottom.
Source: StockCharts
Unsurprisingly, Snowflake was very weak against its peer group from the December high, but since the May bottom, it has done quite well against the software index. That's even more impressive when we look at the bottom, where we can see a huge amount of outperformance from the group against the S&P 500. In other words, we have a stock that is outperforming an outperforming group. This virtuous combination is exactly what you want to see.
The TL;DR on the chart is that there's significant overhead resistance at $328, but I see this pullback as a pause that refreshes before a new rally is unleashed.
Let's talk about Snowflake's fundamentals
I did a full write-up of Snowflake's model and why I like it long-term in the linked article above, and nothing about that has changed. I still like the model, and I still think Snowflake has an extremely bright future consisting of years of immense revenue growth. Thus, let's focus on the future instead of rehashing what the business does.
We'll start with a recap of Snowflake's recent growth, which is unbelievably impressive.
Source: Investor presentation
Snowflake bills when its customers consume the product, so these are not some sort of revenue schedule from a subscription model; this is actual evidence of Snowflake's platform being used at much higher rates from period to period over time. Revenue more than doubled last year, and is set to roughly double this year, with Q2 revenue up 104%. This is nothing new for those of us that have followed Snowflake, but it is worth reiterating just due to the absolutely massive growth rates this company is achieving.
It is doing so by adding new customers - including 116 now that produce at least $1M in annual revenue each - as well as 212 Fortune 500 customers. These are some of the largest companies in the world and can use whomever they like for the services they need; they're collectively putting their stamp of approval on Snowflake, which will only bolster its perception among prospective customers.
This burgeoning customer list also provides R&D benefits, as there is more cash coming in to fund R&D to improve the platform, but big customers can also help Snowflake by providing feedback and suggestions for enhancements. This is a virtuous cycle that every software company aims to achieve, and Snowflake is well within it. Provided it can continue to innovate, this cycle should continue for years to come, driving ever-higher revenue totals as more and more customers adopt the platform, and find more and more ways to use it.
Perhaps that's why there's a Grand Canyon worth of white space between the revenue estimates of years out to 2027 below.
Source: Seeking Alpha
That white space means there's a big gap in revenue between one year and the next, and you can see that in five years' time, Snowflake should have ~7.5X the revenue it has today. Snowflake is still relatively small in terms of software revenue at $1.1 billion forecast for this fiscal year. That means there is ample room for massive growth without it having to go take it from someone else. In other words, the pie itself is huge and growing rapidly, so it makes the path of least resistance higher for competitors like Snowflake.
We all know that scale is the key in software, and we're already seeing the benefits of that with Snowflake's margins.
Source: Investor presentation
R&D remains a massive expense, and almost certainly will for years to come. However, as product revenue continues to move higher, we should see sales and marketing, R&D, and G&A costs decline as a percentage of revenue steadily, even if those categories cost more from a dollar perspective. Snowflake is expected to be FCF positive this year, which is extraordinary given it is a relatively new platform, and bodes well for the future given margins are already strengthening as much as they are so early on. Strength in margins has accrued from better scale, but also discipline over discounting practices, and larger, enterprise customers coming on board.
Source: Investor presentation
Guidance is for 92% revenue growth for this year, but gross profit should be ~400bps higher than it was last year as well. This is the sort of leverage Snowflake will continue to improve upon in the years to come, and why the stock is priced the way it is.
SNOW stock - Look elsewhere for a cheap valuation
Of course, all of this awesomeness doesn't come cheap, as I shall now demonstrate. Below we have the stock's price to forward sales ratios for the time it has been public.
Source: TIKR.com
Shares peaked at an eye-watering 119X revenue last November, which is almost difficult to fathom. However, shares quickly fell to a much more modest 45X times forward sales by May, as the combination of a plummeting share price and soaring revenue helped drive the multiple lower. Today, shares go for 59X times forward sales, so it certainly isn't cheap. But if you wait around for it to be cheap by any sort of traditional metric, you might as well just forget about it and move on; if you want to own premium growth, you have to pay a premium price.
However, if we look at the below, we can see that a premium is actually in order when it comes to Snowflake and its relative growth rates against peers.
Source: Seeking Alpha
This is a smattering of other software stocks with lower valuations, but also much lower revenue growth rates. Snowflake is more than double the growth rate of the next closest one, so why shouldn't it have a massive valuation premium? That sounds perfectly logical to me, and so long as Snowflake maintains its leadership in terms of revenue growth, that valuation premium should persist. Small wonder Snowflake is right at the top of Seeking Alpha's rankings for a set of its peers.
The bottom line on Snowflake is that I see a very bullish setup on the chart, and I think the stock is going to bounce from here and move a lot higher. I'll caution that the prior high of $328 likely won't be that easy to break through, but I have no doubt the stock will breakthrough, at least not based on what I see today.
The valuation is steep, but it always will be. We're talking about a company with ~100% annual revenue growth rates for the foreseeable future, a great product, and a prestigious and growing customer list. When we put all of this together, I see a very bright future for Snowflake, even if it is up 29% since my last bullish call.
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