Snowflake Is Overvalued: Here Are 3 Massive Reasons To Avoid It (NYSE:SNOW)


Introduction

The biggest IPO of the year, Snowflake (SNOW) went live Wednesday, September 16. The company originally scheduled an IPO price between $75 and $85 but increased it all the way to $120 on IPO day after seeing substantial demand for shares.

The stock opened even higher at $245 and ran up to a whopping $319 per share before settling just above $250 on day 1. As of the close on Thursday, September 17, the stock has traded down to around $224 per share.

Data by YCharts

I rarely am one to call a stock overvalued. I’m a growth investor and don’t mind paying up for great companies. Snowflake meets virtually all my requirements, but as you’ll see below, I think investors should avoid this stock for now and wait for potentially better entry prices in the future. Snowflake is very likely overvalued at current prices.

Reason #1 – Price Is A Function of Supply and Demand, Not Value

The first reason investors should consider avoiding this stock is that when companies IPO, they issue a limited amount of shares. If the company is hyped up enough, demand for shares will greatly exceed available supply, which is exactly what has happened with Snowflake. Anybody that knows anything about economics can tell you what happens to price when demand greatly exceeds supply.

In this case, Snowflake issued just 28 million shares (with an option for an additional 4.2 million shares) out of a total of over 270 million shares. Essentially, only about 10% of all outstanding shares are available for trading on day 1. Combine the limited share float with extremely high demand, and you can get a situation where a small minority are willing to overpay for a limited number of shares, causing the price to skyrocket. This is clearly not a reflection of fair value. Those buying it likely want to own it just because they want to own it, not that dissimilar to something like a Ferrari, not because it’s an attractive valuation. This strategy is not a prudent one for those looking to actually make money.

Reason #2 – Lockup Expiration On The Horizon

When companies IPO, there is generally a period of time during which insiders cannot sell their shares. This is done to keep companies and insiders from building up hype and going public only to immediately dump stock on the awaiting public. Unfortunately, while in theory, this should work to dispel market manipulation, in reality, the effect remains similar when share supply is extremely limited at first.

Snowflake filed their final 424B4 filing on September 16, 2020, and in that filing disclosed the following:

Source: SNOW 424B4 SEC Filing

As of 91 days from September 16, 2020, most employees can sell 25% of their vested shares. If my counting is correct, this date is December 16, 2020. This means up to 11.3 million additional shares could be sold in the open market in mid-December, diluting the available float by around 40%. After December 15, 2020, if the stock exceeds 133% of the IPO price (around $280 per share) for 10 trading days, another 38 million shares will be available for selling by insiders. This would nearly double the available float.

Finally, all shares will become available for sale after the second trading day following the company’s second quarterly or annual report after the IPO. I was unable to find exact dates for this, but investors need to look out for the week or so following the company’s second quarterly report as a public company. If shares remain at an elevated level, I could see substantial selling from insiders coming in, leading to further price declines.

Reason #3 – Ridiculous Valuation

Finally, I saved the biggest reason for last. The stock just trades at an unreasonable and ridiculously high valuation. In fact, I’ve never seen anything like it in a large-cap company.

Just look at the price to sales ratio of the following companies. I’ve included some of the hottest, most highly valued companies in the entire market. It isn’t even close. Snowflake has a price to sales ratio several multiple times higher than Shopify (SHOP) and nearly 50% higher than even Zoom (ZM), which reported 355% revenue growth last quarter. Snowflake’s revenue growth rate is under 150% and will likely only drop from here going forward.

ChartData by YCharts

Conclusion

To put it simply, there is currently an extremely high demand for shares of SNOW and relatively little supply. This has caused a fundamental disconnect between price and value. Investors, in my opinion, should avoid this stock. With supply scheduled to come online over the next 3-6 months and the stock trading at one of the highest valuations ever in stock market history, investors are likely better off putting their money elsewhere. It is likely that the valuation comes down and more shares flood the available float over the next few months, leading to a lower stock price.

I’ll be writing more articles on great (or sometimes not so great) stocks and ETFs. If you enjoyed this article and wish to receive updates on my latest research, click “Follow” next to my name at the top of this article. Also, consider checking out the links to my social media pages on my Seeking Alpha profile.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a short position in SNOW over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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