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These Two Things Need To Happen Before Snap Stock Bounces Back

The fate of Snap stock will be determined by the company's usage rates and monetization levels

By Luke Lango, InvestorPlace Contributor

Snap Inc (SNAP) Stock: The Gains Will Be Ephemeral

Source: Shutterstock

Life as a public company has been less-than-stellar for Snap (NYSE:SNAP) and Snap stock.

The photo-sharing company went public to significant fanfare in early March at $17 per share. Within a day, excited investors pushed Snap stock up to nearly $30. That was the end of the rally. Since then, it has been nothing but downhill for Snap stock, excluding one big, post-earnings pop.

Today, Snap stock trades slightly over $7. That is 60% below its IPO price and more than 75% off its all-time high. Clearly, investors have given up on the stock.

Wall Street analysts are starting to give up, too. Most have become much more bearish. Long-time bull Goldman Sachs recently cut its price target on Snap stock by 35% to $11, while MoffettNathanson recently reduced its price target to $6.50. Evercore, Citigroup, and Aegis have all cut their estimates on Snap.

But analysts’ consensus price target on Snap is still roughly $11, representing nearly 60% upside from current levels. So what should you pay attention to more? The fact that investors are selling Snap stock in droves and analysts are cutting their forecasts for Snap or analysts’ belief that the stock will rise 60% in 12 months.

The short answer is that you have to pay attention to both. Falling estimates and eroding sentiment are a sign of the times, and these are troubled times for SNAP. But if the company can prove that its user metrics are stabilizing, while its monetization is improving, then Snap stock could quickly soar back to $10-plus.

Thus, your game plan for SNAP stock should be simple. Don’t rush to buy the current dip. Wait until the company’s earnings come around. Make sure the numbers are good and show signs that user metrics are stabilizing, while monetization is improving. Then, if those conditions are met and Snap stock rallies, buy the shares.

The Two Things Snap Needs to Prove

The whole digital advertising sector has been weighed down by slowing digital ad growth and concerns about intensifying regulations. But those two broad concerns seem overstated and premature. Regulation concerns are overstated because any new regulations probably won’t adversely affect spending on digital ads. Meanwhile, concerns about slowing digital ad growth are premature because the digital ad market is still growing at a 15%-plus clip.

There are two other major concerns that are specific to Snap. First, the company’s user base appears to have peaked, and signs indicate that its users are increasingly migrating to Facebook’s (NASDAQ: FB) Instagram. Second, Snap’s monetization rates remain anemic, and management has yet to prove that it has a sustainable strategy for improving those monetization rates.

Before Snap stock rallies, the company needs to prove that its usage is stabilizing and that its monetization rates are improving. If the Q3 results provide evidence that Snap has made meaningful progress on those fronts, Snap stock could rally, causing sentiment to improve in a big way.

Investors need to see that the company’s daily active user, or DAU, base grew in Q3, while average engagement times continued to rise at a healthy rate. If those things don’t occur, investors will assume that Instagram is eating Snap’s lunch, and SNAP stock will drop. But if Snap’s DAU does indicate that its user base has stabilized, while its engagement rates are increasing, then investors will assume that Snap is holding its own against Instagram, and Snap stock will rise.

Also, the market needs to see Snap’s average revenue per user grow at a meaningful clip. If the market doesn’t see that, the assumption will be that Snap ads aren’t working, and Snap stock will drop. If Snap does report meaningful ARPU growth, though, the assumption will be that Snap’s ads are working, and Snap stock will rise.

Overall, Snap needs to report meaningful DAU and ARPU growth in order to quell investors’ fears and spark a rally in the stock.

Why Snap Stock Could Soar

If Snap’s Q3 report does impress investors, the ensuing rally in Snap stock could be a huge one.

SNAP stock has been severely beaten up over the past several months as most investors have adopted bears’ thesis on the name. Even good news, such as a partnership with Amazon (NASDAQ:AMZN) and the launch of original shows, hasn’t lifted Snap stock. Instead, the stock has taken a one-way road from $13 in August to $7 today.

In other words, investors are deeply negative about Snap stock now. As a result, a meaningful positive catalyst, such as a strong earnings report, could cause the shares to explode higher. Additionally, short interest in the stock has increased as the shares have dropped. Thus, a strong Q3 report could spark a short squeeze which will cause Snap stock to fly higher.

Perhaps most importantly, if you assume Snap can stabilize its user base around 200 million daily users and substantially grow its ARPU to industry-standard levels, then the company’s growth outlook will become quite attractive. According to eMarketer, Snap’s average ARPU last year was about $7. On the other hand, Facebook’s (NASDAQ:FB) was nearly $90. YouTube was at $45, Instagram was at $35, and Twitter (NASDAQ:TWTR) came in at $20.

In other words, Snap has a lot of room to grow its ARPU if the company is able to develop a successful ad monetization strategy.  eMarketer is confident that Snap will be able to do that. The firm estimates that Snap’s ARPU will exceed $30 by 2020. That seems aggressive,  but the firm’s  concept is on-target. Snap does have an opportunity to dramatically grow its revenue and margins through improved monetization rates.

Bottom Line on SNAP Stock

The wait-and-see approach is the best way to handle Snap stock at its current levels. Wait for the company’s Q3 results. See if those numbers confirm that the company’s usage rates have stabilized, while its monetization has improved. If they do, buy the rally. If not, forget about Snap stock until next quarter.

As of this writing, Luke Lango was long AMZN and FB.

Article printed from InvestorPlace Media, https://investorplace.com/2018/10/these-two-things-need-to-happen-before-snap-stock-bounces-back/.

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