One of the biggest concerns last year Snowflake (NYSE: SNOW) investors had was how quickly sales growth declined. But to the data cloud specialist’s credit, the company appeared to get this problem under control by the end of 2024. In fact, Snowflake’s revenue growth accelerated in the first quarter of fiscal 2025 compared to the fourth quarter of fiscal 2024.
But this still misses the full picture. The revenue growth rate that Snowflake has stabilized is impressively high. The tech company grew its first-quarter revenue 33% year-over-year – one percentage point faster than the fourth quarter of fiscal 2024. Management even recently raised its full-year 2025 revenue guidance.
But there is one glaring problem: achieving these growth rates will be expensive.
Growth versus costs
After strong sales growth in the fiscal first quarter, Snowflake management said in its press release for the quarter that it now expects product sales for all of fiscal 2025 (typically approximately 95% of total sales) to increase 24% year over year rise to $3.3 billion. . This was an increase from previous expectations for product sales during the period to increase 22% year over year.
However, management has lowered margin expectations. Snowflake now expects a full-year non-GAAP (adjusted) gross profit margin of 75% (down from the 76% target previously) and an adjusted operating income margin of 3% (down from the 6% target previously ). The company also expects adjusted free cash flow as a percentage of sales to be lower. The new forecast calls for a free cash flow margin of 26%, compared to a previous estimate of 29%.
Snowflake Chief Financial Officer Michael Scarpelli explained in the company’s first quarter earnings call that the higher expected costs are due to higher graphics processing unit (GPU) costs associated with its artificial intelligence (AI) initiatives from the company.
“We operate in a rapidly evolving market and we view these investments as key to unlocking additional revenue opportunities in the future,” Scarpelli said during the company’s first-quarter earnings call.
Prioritize AI
Not surprisingly, the company is doubling down on its AI efforts. When Snowflake announced a CEO transition earlier this year, new CEO Sridhar Ramaswamy made it clear that AI would be a key focus under his leadership.
“Generative AI is at the forefront of my conversations with customers,” Ramaswamy said during the company’s quarterly financial results in February. “This brings a renewed emphasis on data strategy to prepare for these new technologies.” Ramaswamy then told investors that AI has created a “huge opportunity” for Snowflake. Capturing this will require a “clear focus” and faster innovation, he stressed.
A demanding appreciation
If Ramaswamy is right and AI really does represent a huge business opportunity for Snowflake, it’s possible that the company’s current investments will pay off in greater revenues and – ultimately – bigger profits. But will the gains be big enough and come fast enough to justify the stock’s valuation? Time will tell. And herein lies the risk for investors who buy the shares at the current price.
Snowflake stocks are expensive. Its market capitalization stands at approximately $49 billion at the time of writing this article, despite reporting a cumulative net loss of $927 million for the last twelve reported months on revenues of just over $3 billion.
Investors interested in Snowflake stock should keep in mind that the tremendous growth and earnings improvement from continued innovation are already priced into shares at their current valuation. Even if the high cost of AI investments is worth it, the stock may already have priced in its potential upside.
Given the stock’s sky-high valuation and the rising costs associated with AI investments, it may be worth staying on the sidelines for now. Revenue growth is great, but investors should demand more from Snowflake at the stock’s current valuation.
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Daniel Sparks and his clients have no positions in the stocks mentioned. The Motley Fool holds and recommends positions in Snowflake. The Motley Fool has a disclosure policy.
Snowflake is growing like crazy. But at what price? was originally published by The Motley Fool
