The stock market is having trouble finding its footing as rising interest rates threaten economic growth, tariffs threaten corporate profit margins, and regulation threatens to depress secular digital growth trends. Amid this stock market slump, social media company Snap (NYSE:SNAP) has been an especially big loser. SNAP stock trades at all-time lows and is down nearly 50% since the company’s last earnings report in August.
Snap’s next earnings report is just around the corner. The company is set to report its third-quarter numbers after the bell today. Considering SNAP stock has lost essentially half of its value since the company’s last earnings report, it is safe to say that investors aren’t expecting much from the company’s Q3 results.
But the weakness of SNAP stock heading into the Q3 results actually implies that the risk-reward ratio of the shares is favorable at this point. I don’t think the company’s numbers will be great. But I do expect the report to include some upbeat aspects, including robust advertising volume growth and steady usage trends. Considering the stock has dropped 50% over the past few months and trades at all-time lows, those positives could enable SNAP stock to rally in the wake of the results.
Advertising Trends Are Positive And Should Improve With Time
Snap’s Q3 revenue growth will be a mixed bag. Revenue growth was probably weak due to lower ad prices from programmatic advertising, but those lower ad prices are apparently driving a huge increase in advertising volume. The big idea here is that advertising volume growth is more important than ad price deterioration because eventually ad prices will increase in the auction-based pricing system as more advertisers shift greater shares of their budget to Snapchat.
SNAP used to have the most expensive ads in all of social media. That strategy didn’t work. Brands weren’t putting money to work in Snapchat because the costs were too high relative to the return, and it was too difficult to determine whether ads were successful. Recently, though, Snap has switched to programmatic ads. Programmatic ad prices are dramatically lower because humans don’t work on programmatic ads much. Thus, as SNAP has migrated to programmatic ads, its ad prices have dropped a ton.
That isn’t great. Lower unit ad prices mean lower revenues and lower margins, unless the drop in ad prices sparks increases in ad volumes.
But that is exactly what is happening. As ad prices have fallen over the past several months, Snapchat’s ad volumes have surged. Brands are all suddenly moving a large portion of their ad budgets to Snapchat because of its lower cost relative to other social media platforms.
For example, Lounge Underwear plans to increase its Snapchat budget by 400% in November, FabFitFun has increased its spending on Snapchat seven-fold amid lower costs, Curology has been gradually migrating ad dollars from Facebook (NASDAQ:FB) to Snapchat and Jägermeister doubled its Snapchat budget in October.
Those are some pretty impressive trends.
As more and more advertisers move dollars to Snapchat, its ad prices will go up. The more demand there is for auction-based programmatic advertising, the higher ad prices will go.
Ultimately, then, SNAP is on the right path in terms of monetization. The company’s Q3 results should show a surge in ad volume, and such a rebound could serve as a positive catalyst for the much-maligned SNAP stock.
Long-Term Value Is There If You Believe in Snap’s Staying Power
There are a few things you have to believe in order to be bullish on SNAP stock in the long run.
First, you need to believe that the platform has staying power among consumers. Second, you need to believe that the platform has staying power among advertisers. Third, you need to believe that eventually, Snap will build its own data centers and greatly improve its profitability.
I believe that all three of those things will happen in the long-run. Snap’s user base will stabilize around 200 million users. Its advertising rates will improve as its scale rises and more marketers buy ads on its website. And Snap’s data-hosting costs will drop as it builds its own data centers after 2022.
Based on those assumptions, I believe that in a decade Snap’s revenue can reach $5 billion, while its EPS can jump to $1. Place an average forward price-earnings multiple of 16 on that, and discount back by 10% per year. You arrive at a present value for SNAP stock of $7.50. Thus, at current levels, SNAP stock looks attractive for long-term investors.
Bottom Line on SNAP Stock
The markets are messy right now, so there is no guarantee that SNAP stock will pop after its results. But SNAP stock is really beaten up, and its ad volume probably jumped in Q3. As a result, the risk-reward of SNAP stock looks favorable ahead of the company’s Q3 results.
As of this writing, Luke Lango was long SNAP and FB.
