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Here's Your Chance to Invest Like Warren Buffett

Motley Fool - Wed May 18, 6:35AM CDT

Famed investor Warren Buffett has traditionally shied away from technology investments throughout his long and historic career. Top holdings of his company Berkshire-Hathaway(NYSE: BRK.A)(NYSE: BRK.B) are made up of mainstream stocks like Coca-Cola, American Express, and Bank of America.

But that doesn't mean he'll ignore a tech stock opportunity when it comes along. Buffett and Berkshire bought a stake in Apple in 2016, and it has since grown to become Berkshire's largest holding. In September 2020, data warehouse specialist Snowflake(NYSE: SNOW) went public, and Berkshire participated in the IPO, capturing a stake worth $250 million (at the time) at $120 per share.

The stock soared to more than $300 when it debuted in trading, but today it is setting new lows, trading at around $143 a share. Investors could soon grab the stock at the same price Buffett did. Let's look at why they should consider buying the stock around this price.

Technology graphic of a snowflake.

Image Source: Getty Images.

Why is Snowflake's stock price falling?

Sometimes, dramatic events have simple explanations. Snowflake stock's 60% decline from its highs resulted from going public with a ton of hype during a time when investors were thirsty for flashy new stocks.

Snowflake was indeed flashy; Warren Buffett himself, notorious for avoiding technology stocks over the years, participated in the IPO! This against a backdrop of near zero-percent interest rates fueled exuberant investor excitement -- an exuberance that contributed to the current bear market.

You can see in the chart below how Snowflake went public at a price-to-sales ratio of more than 150 and soared higher still, making it one of the most expensive stocks on all of Wall Street.

SNOW PS Ratio Chart

SNOW PS Ratio data by YCharts.

It only makes sense that such outlier stocks will eventually see a heavy correction when the tide goes out, and Snowflake's valuation seems like a great example. Such a high P/S ratio is simply uncommon in virtually any market scenario.

Operating excellence

While it's difficult for any business to support such a high valuation over the long term, it's essential to understand why the stock may have received so much hype in the first place.

Snowflake's a business with robust growth metrics; the chart below shows that year-over-year revenue growth has been exceeding 100% for multiple quarters. Free cash flow has turned positive thanks to rapid revenue growth outpacing what Snowflake spends -- the business is converting 15% of its revenue into cash flow, which could increase as the company continues growing.

SNOW Revenue (Quarterly YoY Growth) Chart

SNOW Revenue (Quarterly YoY Growth) data by YCharts

Many high-growth companies lose money for years after going public, so it should be a significant boost to investor confidence that free cash flow is already positive. Net income, which is bottom-line profit, isn't positive yet. However, that's primarily due to share-based compensation; the company has a net income of minus $605 million, against $680 million in stock-based compensation expenses over the past 12 months. It's common for employees to receive share-based bonuses when a company goes public, which should slow over time.

Years of growth ahead

Meanwhile, Snowflake's long-term outlook looks very promising. Snowflake grew customers 44% year over year to 5,944 in the quarter ending Jan. 31. The company has a net-revenue retention rate (NRR) of 178%, meaning that customers spend more as they use Snowflake over time.

Meanwhile, data should play a large role in enterprises over the years ahead. Snowflake is a "cloud data platform" that enables companies to organize, learn from, and share their data seamlessly, an opportunity Snowflake values at roughly $90 billion.

Data doesn't expire, and enterprises create more over time, so the addressable market could keep growing. Most of Snowflake's billing is consumption-based, which bodes well for future revenue growth. Snowflake's management is targeting $10 billion in revenue by its fiscal 2029 year, up from $1.2 billion at the end of fiscal 2022.

The stock trades at a P/S of 37, not cheap but far more digestible than when the company IPO'ed. Warren Buffett is one of the greatest investors in history, and he is known to be a specialist at jumping on a good deal. As Snowflake drifts toward what Buffett himself bought the stock at, investors could get a similar chance to eventually benefit from this hyper-growth stock.

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Bank of America is an advertising partner of The Ascent, a Motley Fool company. American Express is an advertising partner of The Ascent, a Motley Fool company. Justin Pope has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Apple, Berkshire Hathaway (B shares), and Snowflake Inc. The Motley Fool recommends the following options: long January 2023 $200 calls on Berkshire Hathaway (B shares), long March 2023 $120 calls on Apple, short January 2023 $200 puts on Berkshire Hathaway (B shares), short January 2023 $265 calls on Berkshire Hathaway (B shares), and short March 2023 $130 calls on Apple. The Motley Fool has a disclosure policy.