This has been a topsy-turvy year for Wall Street and the investment community. Though volatility never disappears from the stock market, we've borne witness to the wildest vacillations in history. The broad-based S&P 500 sank like a stone during the first quarter and lost 34% of its value in under five weeks. It also rebounded aggressively from its March 23 low, taking less than five months to regain all that was lost.
But the records just keep coming.
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Snowflake makes IPO history
Last week, cloud-based software-as-a-service giant Snowflake (SNOW +1.01%) debuted in what's become the largest software initial public offering (IPO) in history. Snowflake raised approximately $3.4 billion after upping its list price to $120 a share, but saw its shares end the first day of trading at nearly $254. Amazingly, Snowflake left roughly $3.8 billion in would-be capital on the table.
The reason this company has created so much buzz is its phenomenal growth rate. In fiscal 2020, which ended Jan. 31, Snowflake delivered $264.7 million in full-year sales, representing year-on-year growth of 174%. In the recently completed fiscal second quarter, sales grew 121% from the prior-year period. Snowflake is adding new customers hand over first (including big-spend customers), and produced a net retention rate of 158% in Q2 2021. This figure suggests that existing customers are scaling their operations and spending a lot more.
Investors are also enamored with the company's game-changing cloud approach. Instead of a subscription plan, Snowflake offers a pay-as-you-go system. Its customers pay based on the amount of data stored and the number of Snowflake Compute Credits they use. This should allow businesses to better manage their cloud storage expenses.
Additionally, since Snowflake's platform is built atop other popular infrastructure services, it allows for ease of sharing, especially with other Snowflake users. No longer are businesses confined to a single infrastructure-as-a-service provider.
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Three cloud stocks to buy instead of Snowflake
Unfortunately, all of this euphoria has pushed Snowflake's valuation into the stratosphere. It closed with a market cap of more than $70 billion on day one, and still carried a $63 billion valuation as of Thursday, Sept. 17. Even if Snowflake more than doubles its sales in fiscal 2021, we're looking at a multiple of over 100 times sales. That's pretty crazy, even with the company's innovation and growth prospects.
Instead of chasing Snowflake, I'd much rather buy the following three cloud stocks. Take note, my definition of "cloud stock" includes the entire cloud gamut, and not just companies that could specifically compete with Snowflake.
Fastly
First up is edge cloud platform provider Fastly (FSLY +10.83%), which has been among the hottest cloud stocks on Wall Street in 2020. The thing realize here is that we were already seeing a steady shift away from the traditional office environment and brick-and-mortar retail toward the cloud well before the coronavirus pandemic hit. What the coronavirus disease 2019 (COVID-19) has done is magnify the need to deliver content quickly and securely to end users. That's where Fastly's solutions have become so valuable.
It's not just that Fastly is picking up new customers. What really stands out is the number of brand-name companies relying on its content delivery network, and the willingness of existing clients to spend more. Thus far, Fastly claims social media behemoths Twitter and Pinterest as clients, along with e-commerce cloud platform Shopify and internet sharing sensation TikTok.
Further, in the most recent quarter, Fastly reported a dollar-based net retention rate of 137%. That was up 5 percentage points from the sequential first quarter, with the average enterprise client spending approximately $716,000, up from $557,000 in the year-ago period. As businesses have grown their digital presence, they're spending more with Fastly, which'll be the company's key to rapidly expanding its operating margins.
Though Fastly might appear a bit pricey at 29 times estimated sales for this year, it's also expected to more than triple full-year revenue by 2023 to $614 million. It's a far more attractive buy than Snowflake.
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Okta
Another cloud stock I'd much rather own instead of Snowflake is cloud-native identification security play Okta (OKTA +2.00%).
The beauty of cybersecurity is that it's evolved into a basic-need service over time. No matter how well or poorly the U.S. economy is performing, hackers aren't go to take a day off. Plus, with more businesses than ever shifting online and into the cloud, the importance of security has been magnified. You could rightly say that Okta's pathway to success has never been brighter.
What makes Okta tick is the company's reliance on artificial intelligence, as well as the growth of its existing clients. Instead of building static identity solutions, Okta's identity verification tools are highly scalable and designed to grow smarter over time. By this, I mean Okta's solutions become better at detecting network and cloud-based threats, making it more effective at keeping unwanted users and robots out of enterprise clouds.
Keeping in mind that the second quarter was the roughest for the U.S. economy in decades, Okta managed to report a 48% increase in current remaining performance obligations -- i.e., contract revenue that's expected to be recognized over the next 12 months -- from the prior-year period. Similar to Fastly, Okta's expansive margins are dependent on generating additional revenue from existing users, and the scalability of Okta's platform appears to be doing just that.
With highly transparent and predictable revenue (95% of Okta's sales are from subscriptions), and the company potentially on track to nearly quadruple sales between fiscal 2020 and fiscal 2024, it's a cloud stock that has plenty of upside.
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Amazon
Last, but not least, you wouldn't have to twist my arm to get me to buy into Amazon (AMZN 0.73%), which is actually a company I already own a stake in.
There's little question that Amazon is known best for being the premier e-commerce company. According to an estimate from Bank of America/Merrill Lynch, Amazon is responsible for 44% of all e-commerce sales within the United States. That's a pretty enviable position to be in, even if retail margins aren't all that great. After all, the U.S. is the No. 1 economy in the world, and it's reliant on consumption.
But the most exciting aspect of Amazon's operating model is its burgeoning infrastructure-as-a-service segment known as Amazon Web Services (AWS). Based on the $10.8 billion in sales recorded in the second quarter, AWS looks to be a year or less away from an annual run-rate of $50 billion in sales. It's worth noting that, despite these big numbers, AWS still grew sales by 29% from the prior-year period during the most challenging quarter for the U.S. economy in a long time.
What investors should understand about AWS is that its margins are light years higher than what Amazon nets from retail and ad-based revenue. AWS is almost always responsible for more than half of the company's operating income. AWS will also be the driving force behind an expected tripling in operating cash flow by 2023.
Considering that Amazon has been valued between 23 times and 37 times its operating cash flow over the past decade, its stock could reasonably double from here by 2023 and fall right in the middle of this valuation range.
