Millennials: Buying Snap Inc (SNAP) Stock Broke a Cardinal Rule

SNAP stock - Millennials: Buying Snap Inc (SNAP) Stock Broke a Cardinal Rule

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TD Ameritrade Holding Corp. (NASDAQ:AMTD) announced Q2 2017 earnings April 19. Its conference call with analysts included remarks about the positive effect the Snap Inc (NYSE:SNAP) IPO had on young people opening new brokerage accounts to buy SNAP stock.

Buying Snap, Inc. (SNAP) Broke a Cardinal Rule

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TD Ameritrade’s trades per day during the second quarter set a record of 517,000, thanks in large part to the frenetic buying and selling of SNAP stock, including 200 million shares on the first day alone.

“Snap was good for us in a lot of ways. We saw strong trading, we saw a lot of clients that opened new accounts that Snap was their first trade,” said TD Ameritrade CEO Tim Hockey in its conference call.

“People buy what they know, and younger people know social media.”

Why Millenials Bought SNAP Stock

Millennials who bought SNAP stock were following the advice (sort of) of former Fidelity Magellan portfolio manager Peter Lynch, who ran the large mutual fund for 13 years, between 1977 and 1990, delivering a 29% annualized return.

I say “sort of” because most millennials have probably never heard of Peter Lynch and, even if they had, Lynch’s “invest in what you know” mantra is widely misinterpreted by investors.

“I’ve never said, ‘If you go to a mall, see a Starbucks and say it’s good coffee, you should call Fidelity brokerage and buy the stock,'” Lynch said in a December 2015 MarketWatch article. “People buy a stock and they know nothing about it. That’s gambling and it’s not good.”

So, here you have investors buying SNAP stock because it’s what they know, something TD Ameritrade’s CEO has identified as a cause for his firm’s increased trade volumes.

The problem, as Lynch sees it, is that there’s knowing about a stock and then there’s really knowing about a stock. The kind of under-the-hood research that gives you enough confidence to buy and hold a stock for a decade or more.

Snap Inc Is About More Than Just Using Snapchat

Young investors who bought Snap might have followed Lynch’s mantra, in theory, but they failed to follow it in spirit. Neglecting to fully comprehend Snap Inc’s precarious financial position and lack of profitability — analysts estimate it will make its first annual profit in 2021 — most definitely could come back to haunt them.

Sure, they might have read the section of the Snap Inc. prospectus that warned “it may never achieve or maintain profitability” and reflected on this warning, but I highly doubt it.

The reality is that anyone who bought SNAP stock, young or old, broke one of the cardinal rules of investing: Buy profitable businesses at reasonable prices.

Well, Snap lost $514.6 million and $372.9 million in 2016 and 2015, respectively. That’s strike one. Strike two is the IPO valuation of SNAP stock, which hit trading at 37 times EMarketer’s 2017 estimate for Snap Inc’s advertising sales.

By comparison, Facebook Inc (NASDAQ:FB) trades at 15 times its current revenue and earned $10.2 billion in 2016. When Facebook went public in May 2012, it was valued at 28 times sales, 25% less than SNAP. Of course, Facebook didn’t lose $515 million the year of its IPO (it made $1.0 billion, 300% more profit than Snap Inc).

I recently wrote about the pros and cons of Facebook buying SNAP, something it tried to do back in 2013, but was turned away by the founders. In hindsight, we know that co-founders Evan Spiegel and Bobby Ryan were wise to turn down the $3 billion offer because, profits or no profits, SNAP is worth almost 10 times that just four years later.

Bottom Line for SNAP Stock

Ultimately, I decided that Facebook should wait and see what happens to Snapchat over the next 12 to 24 months. Perhaps it falters and Facebook can pick it up for less than its current $25 billion market cap, or Facebook’s own apps might just overtake it.

I’m sorry, but young or old, if you bought SNAP stock, you broke a cardinal rule of investing. That usually comes back to haunt you.

As of this writing, Will Ashworth did not hold a position in any of the aforementioned securities.

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