Social media company Snap (NYSE:SNAP) reported third quarter numbers after the bell on Thursday, 10/25, and the company actually topped both revenue and earnings estimates. But, Snap also said that its Snapchat platform continues to lose users, and that this trend likely won’t reverse any time soon. As such, after popping as much as 10% in after-hours trade, SNAP stock reversed course sharply. As of this writing, the stock is down more than 10% in Friday afternoon trade.

What is the big takeaway here? Should investors focus on improving monetization and margins, and buy the dip? Or should they focus on continued user churn, and avoid SNAP?

I think the latter. SNAP still isn’t cheap by any means. It trades at more than 7X trailing sales. While that is below the 8-plus trailing sales multiples at Facebook (NASDAQ:FB) and Twitter (NYSE:TWTR), both of those companies are profitable, both of them are still growing daily users, and both of them are dramatically improving monetization rates.

In other words, in order to justify its current valuation, SNAP stock really needs three things: a clear pathway to profitability, user base stabilization and preferably user growth, and improving monetization trends.

The third quarter report gave us improving monetization trends. But, the user base is still dropping, and with the user base in decline, the pathway to profitability is less clear.

As such, we are really only getting one of the three things we need to own SNAP here and now. That makes SNAP a “must avoid” in the near-to-medium term.

Snap’s Quarter Wasn’t Very Good

Broadly speaking, Snap’s third quarter earnings report was characterized by impressive revenue trends, improving margin trends, and still disappointing and worsening usage trends.

Revenues rose by 43% year-over-year. That is better than Wall Street expected. Impressively, average revenue per user (ARPU) rose 37% year-over-year, better than expected and up from 34% growth last quarter.

Strong ARPU growth led to healthy gross margin expansion of 15 points year-over-year and six points quarter-over-quarter. Healthy gross margin expansion narrowed the company’s operating loss by essentially $120 million year-over-year.

In other words, Snap’s advertising initiatives are taking hold, and the company is making substantially more money per user than they were a year ago. That is allowing margins to improve and helping narrow losses.

That is the good news. The bad news is that Snap continues to lose users. Snap’s daily active user base shrunk from 188 million in Q2 to 186 million in Q3. The user base has now shrunk in two consecutive quarters, and is expected to shrink again next quarter. This means that user shrinkage is more than just an anomaly. It appears to be the new standard.

Thus, Snap’s quarter was some good and some bad. The company finally appears to have its act together on the advertising front and is using improved measurement tools and low ad prices to attract advertisers. Improvements therein are driving improvements throughout the financials. But, the user base continues to shrink.

If user churn persists, it won’t matter how good Snap gets at monetizing. The current valuation on SNAP stock won’t hold up in a long term window.

Snap Stock Needs More to Justify its Valuation

SNAP trades at essentially the same sales multiple as Facebook and Twitter.

Both Facebook and Twitter are profitable. Snap is not. Both Facebook and Twitter are growing their daily active user bases (Twitter is losing monthly actives, but growing daily actives). Snap is not. Both Facebook and Twitter are improving monetization rates at a healthy pace. Snap is too.

Thus, in the big picture, Snap is doing one of the three things it needs to justify its current valuation. That just isn’t enough. In order for SNAP stock to head higher, it needs usage stabilization and a clear pathway to profitability.

Unfortunately, it doesn’t look like you will get either of those any time soon. The user base has now dropped in back-to-back quarters, and surveys everywhere indicate that Instagram is simply kicking Snap’s butt in terms of daily usage.

Moreover, management guided for the user base to again shrink in Q4. At this point, the only thing that could turn the churn trend around is an Android app revamp. But, Snap has struggled with this to date, and until this actually happens, the market won’t price in this catalyst.

On the profit side, Snap doesn’t own any data-centers, so they have huge data hosting costs which provide a drag on gross margins. Those data hosting costs will be there until 2022 (Snap has contracts in place until then), so profitability within the next five years requires both robust ARPU and user growth. If user growth stays negative, profitability is a big question mark.

Overall, SNAP stock simply isn’t giving the market enough to justify its current valuation. There is hope for a long-term turnaround if the Android revamp reinvigorates user growth, the company commits to building its own data-centers, and advertisers continue to flock to the platform even if programmatic ad prices rise.

All three of those things could happen. But, SNAP has become a “show me” situation, so the market won’t price in any of those catalysts until they happen.

Bottom Line on SNAP Stock

Because of continued user churn, the near to medium term outlook on SNAP stock is dour. Longer-term, this stock does have enormous upside potential if the stars align. But, investors should wait for those stars to align before buying the dip.

As of this writing, Luke Lango was long FB.