Snowflake and the Snowballing Impact of its AI Flywheel

Key Points

• Snowflake's AI flywheel accelerates as client growth and penetration improve.
• A new deal with AWS paves the way for sustainable growth over time.
• Analysts responded favorably, leading this market to a multiyear high.

Snowflake NYSE: SNOW is only the latest example of how the AI flywheel is gaining momentum. Demand for the company’s product is hot, exceeding expectations and driving management to increase spending. Increased spending leads to new demand, increased revenue, and an improved outlook—and the cycle has only just begun.

The likely outcome is that Snowflake and other well-positioned software-as-a-service companies will continue to accelerate in the coming quarters and sustain high-level growth well into the future. More importantly, Snowflake, unlike some other AI up-and-comers, is profitable and driving intrinsic value for its shareholders.

Snowflake Accelerates in Q1, Guides for Strength in Q2

Snowflake had a robust quarter, as shown in its Q1 earnings: revenue growth accelerated to 33%, outpacing consensus by over 500 basis points, the strongest growth in nearly three years. The $1.39 billion in revenue was underpinned by a 34% increase in product sales, driven by new clients and increased penetration. The number of large clients contributing more than $1 million in annual recurring revenue increased by 29%, while net new clients increased by 28%. Net retention, a measure of revenue generated from existing clients, was also strong, up by 126% as AI adoption continues to accelerate.

Margin news was also good. The company keeps posting GAAP losses due to heavy investments, but remains profitable at its core. Adjusted earnings per share came in at 39 cents, up more than 60% year-over-year and 2,200 bps above forecasts, outpacing the top-line strength by 1700 bps. Looking ahead, strength is expected to continue, and the guidance may be overly cautious.

Management forecasts Q2 revenue to grow 30% at the midpoint, which was better than expected, and raised the full-year revenue target by 400 bps. The $5.84 billion target implies a 31% year over year increase and will likely be increased again before the year is over. Remaining performance obligation, the measure of contracted but unearned revenue, grew by 38%, suggesting business momentum continues to grow.

Analysts' Revisions Go Into Overdrive—Snowflake to Hit Fresh Highs

Analysts responded robustly to the news. MarketBeat tracked a half dozen revisions within the first few hours of the release, affirming the bullish trends and leading price action to the high end of the target range.

As it stands, the 41 analysts tracked provide high conviction in the Buy rating, with 35 of 41 (85%) ratings pegged at Buy, and a consensus price target of $277. The high-end range of new price targets would be sufficient to put this market at a multi-year high.

Takeaways from the chatter include the impact of the new Amazon Web Services (AWS) deal and the Natoma acquisition. The AWS deal amounts to billions in new spending over the next five years, but for the capacity and infrastructure to drive business. The likely outcome is that Snow continues to gain share and monetizes its investment over time, and the Natoma acquisition amplifies the outlook. Natoma’s platform helps connect AI tools to existing apps, both inside and outside the Snowflake platform, providing utility across the ecosystem.

Snowflake Market Melts Up, Again—This Time It May Stick

Snowflake’s market responded vigorously to the news, rising by more than 30% in its wake. The move signals solid support at the market lows, affirming the deep value presented in early May, and a high probability of continuing higher. The question is whether SNOW will continue higher immediately or whether profit-takers will cap gains. The 30% overnight increase in the stock price made some traders millionaires, creating an unmissable opportunity for profit-taking. Critical resistance targets are near $240 and $280; critical support is near the cluster of exponential moving averages near $190.

Snowflake’s biggest risks are its valuation and competition. Competition for data management is fierce, including from megacap players such as Alphabet NASDAQ: GOOGL and Microsoft NASDAQ: MSFT. While Snowflake provides utility, they have the scale and finances to capture share. In this environment, execution is critical, and the high valuation sets the stage for large pullbacks. Trading at over 100X its current-year earnings, any signs of weakness in upcoming reports or bullish news from competitors will be reflected in the stock’s price. The caveat is that this market is pricing in a robust growth trajectory. Consensus forecasts put this stock below 10X earnings before 2035, suggesting it could rise 100% to 200% from the $235 level.

Short-selling is also a risk, but not as pronounced as it is with some tech names. The short interest was rising ahead of the report, but pegged at only 6% of the shares. It's likely that short covering helped amplify Snowflake’s post-release price surge.