Snap Inc (NYSE:SNAP) dropped sharply back in May following its first quarterly earnings report, but since then, investors have been keeping the faith. SNAP stock has been mostly rangebound between $20 and $21, giving investors time to revisit the Q1 report and turn off the alarms that rang out immediately after the announcement.
The plan ahead is simple: Long-term revenue growth potential depends on Snap being able to grow its user base while attracting its advertisers.
The chances of Snap actually succeeding? Well … it’s mixed.
Snap reported a loss of $2.2 billion in the first quarter, and daily active users grew 36% year-over-year to 166 million, slightly missing expectations of 168 million. That day, the frequency of tag mentions on “Snapchat” surged last month on May 10. Negative sentiment at 27% outweighed positive sentiment at 17%.
But since the stock bounced back, sentiment also improved. Analyst Drexel Hamilton’s upgrade of SNAP stock may have helped lift sentiment.
What Needs to Happen
If Snapchat succeeds in growing user engagement, then advertisers will divide more of their budget on the site. Facebook Inc (NASDAQ:FB) and to a lesser degree, Twitter Inc (NYSE:TWTR) are competing for the same advertisers. So if rumors are true that Snap is running discounts to attract them, that could eventually drive revenues higher.
Snap needs to build revenue momentum for at least the next couple of quarters, which would give it a better chance of making a statement in the crucial end-of-year holiday quarter. Offering ad discounts may lead to market share growth and customer additions.
The risk, of course, is that it can’t rely on discounts for too long without risking lower operating profits — and the company already is turning around big bottom-line losses. So it doesn’t have nearly the flexibility of, say, Alphabet Inc (NASDAQ:GOOGL) to slash prices forever.
But for now, the strategy is the right one. Snap needs volume and familiarity.
Valuation
According to simplywallst, Snap’s intrinsic value is $14.43, based on its future cash flow value.
The company is not expected to report positive earnings until the year 2021. SNAP has no problem growing revenue every year, but negative cash flow implies losses for at least the next two years. Encouragingly, Snap will have a ROE (return on equity) of more than 20% in three years.
Pressure From Facebook
The biggest worry is that Snap continues to face relentless pressure from Facebook. On May 25, Instagram finally added link sharing in direct messages. For years, the app did not allow users to share URLs in direct messages. With 200 million daily active users on Instagram’ Stories, it eclipsed Snap’s count of 166 million DAUs.
Snapchat’s core strengths are the basic filters features. But the company’s decision to capture user location data when using the filters may anger users. Instagram’s copying of selfie filters could lure Snap users over.
For now, though, Instagram still has bugs it needs to iron out before it’s a true threat.
Takeaway on SNAP Stock
Snap is by no means an inexpensive stock, but its losses have knocked away a great deal of froth. The question is whether the company can sustain its pace in user growth while attracting advertisers … while not cutting into its own operations too deeply by discounting to attract those advertisers.
If you can accept the fact that Snap will run unprofitably for some time, SNAP stock isn’t a bad gamble. But it will be a nerve-wracking one.
As of this writing, Chris Lau did not hold a position in any of the aforementioned securities.
