The company's big bet on AI is risky.
Last year, one of the biggest concerns Snowflake (SNOW 0.60%) investors had was how quickly its revenue growth rate was decelerating. But to the data cloud specialist's credit, the company seemed to get this problem under control in late fiscal 2024. Indeed, Snowflake's top-line growth rate actually 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 Snowflake has stabilized at is impressively high. The tech company grew its fiscal first-quarter revenue 33% year over year -- one percentage point faster than it grew in the fourth quarter of fiscal 2024. Management even recently raised its full-year fiscal 2025 revenue guidance.
But there's one glaring problem: achieving these growth rates is going to be costly.
Growth versus costs
After posting strong fiscal first-quarter revenue growth, Snowflake management said in its press release for the quarter that it now expected full-year fiscal 2025 product revenue (typically about 95% of total revenue) to increase 24% year over year to $3.3 billion. This was an uptick from its previous guidance for product revenue during the period to increase 22% year over year.
Management, however, downgraded its margin expectations. Snowflake now expects a non-GAAP (adjusted) gross profit margin for the full fiscal year of 75% (down from a target of 76% previously) and an adjusted operating income margin of 3% (down from a 6% target before). The company also expects its adjusted free cash flow as a percentage of sales to be lower. Its 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 fiscal first-quarter earnings call that higher anticipated costs are due to increased graphics processor unit (GPU) costs related to the company's artificial intelligence (AI) initiatives.
"We are operating in a rapidly evolving market, and we view these investments as key to unlocking additional revenue opportunities in the future," said Scarpelli during the company's fiscal first-quarter earnings call.
Prioritizing AI
It's not surprising that the company is doubling down on AI efforts. When Snowflake announced a CEO transition earlier this year, incoming CEO Sridhar Ramaswamy made it clear that AI would be a key focus under his leadership.
"Generative AI is at the forefront of my customer conversations," Ramaswamy said during the company's fiscal fourth-quarter earnings call in February. "This drives renewed emphasis on data strategy in preparation of these new technologies." Ramaswamy then told investors that AI has created a "massive opportunity" for Snowflake. Capturing it will require a "clear focus" and faster innovation, he emphasized.
A demanding valuation
If Ramaswamy is right and AI really does represent a massive business opportunity for Snowflake, it's possible that the company's investments today will pay off in bigger revenue and -- eventually -- fatter profits, too. But will the profits be big enough and come soon enough to justify the stock's valuation? Only time will tell. And herein lies the risk for investors buying the stock at its current price.
Snowflake stock is expensive. Its market capitalization at the time of this writing is approximately $49 billion despite reporting a cumulative net loss of $927 million over its trailing 12 reported months on sales of just over $3 billion.
Investors interested in Snowflake stock should keep in mind that massive growth and profit improvement from continual innovation are already priced into shares at their current valuation. Even if the high costs of AI investments end up being worth it, the stock may have already priced in its potential upside.
Given the stock's sky-high valuation and the rising costs associated with AI investments, it might be worthwhile to stay on the sidelines for now. Revenue growth is great, but investors need to demand more from Snowflake at the stock's current valuation.
Daniel Sparks and his clients have no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Snowflake. The Motley Fool has a disclosure policy.
