2 Reasons Snap Inc (SNAP) Stock Should Be Left Alone

SNAP stock might never get above the $24 mark again

Snap Inc (NYSE:SNAP) went public on the New York Stock Exchange on March 2 at $17 per share. It quickly jumped above $24 per share, but has lost ground ever since. SNAP stock now sits below the $21 mark … and there’s little reason to believe it’ll ever recapture those early post-IPO highs.

Snap, Inc.
Source: Shutterstock

Snap bulls say it is the next Facebook Inc (NASDAQ:FB), while bears compare Snap to Twitter Inc (NYSE:TWTR). Which will it be? That’s the $64,000 question.

I find it difficult to side with the bulls. Yes, Snap has done some innovative things and might be more loved by younger users, but user growth is already slowing relatively early in Snapchat’s life, and worse, the stock is richly valued while profitability is elusive.

Meanwhile, aforementioned Facebook — which tried to buy Snap but was rebuffed — has been fighting the company by shamelessly copying its features.

SNAP stock has little upside from here. And these are two of the biggest reasons why.

Reason N0. 1: Snap’s Stratospheric Valuation

Some see Snap and other companies such as Tesla Inc (NASDAQ:TSLA) as evidence of a second tech bubble. I don’t know about that, but I find it difficult to argue against the view that Snap is richly valued.

SNAP stock trades at a whopping 47 times sales. Keep in mind that this valuation is for Snap Inc, a company founded in 2010 that never turned a profit and was projected to lose $2 billion in 2017 (more than Tesla and Twitter combined!) … before the company reported it lost $2.2 billion in just the first quarter alone!

As Mantas Skardzius noted, Snapchat trades at a higher price-to-sales multiple than other internet companies like Facebook and Alphabet Inc (NASDAQ:GOOGLdid when they first listed. Facebook traded at 8.64 times sales when it listed in 2012, and Alphabet stock changed hands at 14 times sales when it went public in 2004. So Snap isn’t just at a higher multiple — it’s higher by several times over.

And Facebook and Alphabet were profitable at the time they went public, unlike Snap.

Does this seem reasonable to you?

Bulls will say, “OK, maybe Snap trades at a high price-to-sales ratio, but keep in mind Snap’s revenue grew 589% in 2016.”

Fine, but even when you factor in forecast growth, the company doesn’t look cheap. As analyst Michael Nathanson noted, it trades at 5 to 8 times forecast sales.

In 2020.

Reason No. 2: Snap’s Slowing User Growth

To sustain such a high valuation, Snap needs to continue growing at a rapid pace. The market has very high expectations of Snap’s future growth, and if Snap disappoints, investors will punish the stock.

Internet companies like Snap can grow two different ways. They can increase the number of users, or they can increase the average revenue per user (ARPU).

Snap is showing weakness in user growth. Snap appears to be saturating its target demographic; Samadhi Partners estimated that a whopping 71% of the U.S. population between the ages of 18 and 24 uses Snapchat.   

And Facebook, Snapchat’s archenemy, is copying Snap’s best features on Facebook, Messenger, Instagram and WhatsApp, and this appears to be affecting Snap’s growth. Snap’s quarterly daily active user growth slowed 82% after introduction of Instagram Stories.

Snap may face difficulty expanding overseas, given founder Evan Spiegel’s alleged comments about poor countries (Snap denies these comments, calling it the work of a disgruntled former employee).

One of Snap’s growth engines appears stalled; in the future, Snap’s growth will depend more heavily on ARPU growth.

Steer Clear of SNAP Stock

Snap faces several risks that could potentially drag the stock down. Valuations are at stratospheric levels, and the company is bleeding out billions of dollars this year.

Not only is Snap not profitable; Snap is burning cash like there’s no tomorrow. As Shira Ovide of Bloomberg Gadfly noted, Snap has the distinction of being one of the few companies she’s ever seen to boast a cost of revenue higher than its revenue.

And if that weren’t enough, one of Snap’s two growth engines, user growth, is petering out; slowing user growth means Snap will rely more on ARPU growth.

There’s a small bull case, but it can’t shout over the bears.

As of writing, Lucas Hahn did not hold a position in any of the aforementioned securities.

Article printed from InvestorPlace Media, https://investorplace.com/2017/05/2-reasons-snap-inc-snap-stock-should-be-left-alone/.

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