Why Snap Stock Has Enough Momentum to Move Higher

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Bulls called it right when Snap Inc. (NYSE:SNAP) stock trended upward from the $12 – $15 range ahead of its second-quarter earnings report.  Investors who believed in Snap stock were rewarded when Snap reported its Q2  results. Its losses shrank considerably, and Snap raised its Q3 guidance. Snapchat stock likely has enough positive momentum to move higher still.

Snap Stock Price Rallies After Snap’s Q2 Results

Why Snap Inc (SNAP) Stock Can Climb Much Further

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Snap reported that its revenue jumped 48% year-over-year to $388 million. Snap now takes in $1.91 per user on average, up 37% from last year. Its operating losses fell by $53 million YoY to $305 million. Snap’s DAUs (daily active users) rose slightly from 188 million last year to 203 million. The company benefited from a 7% increase in the number of Snaps (temporary pictures) sent after it refreshed its Android app. Also, the 10% increase in the retention rate of people opening Snapchat for the first time lifted the amount of overall activity on the app.

By growing its user base, Snap will spark increases in its revenues. Just as Facebook (NASDAQ:FB) increased its user base through site and app improvements, along with acquisitions, Snap will do the same. As Snap executes its business plan, the company may reach profitability sooner than anyone thinks. Management already raised its near-term outlook, a good sign for the owners of Snap stock.

Higher Q3 Outlook

Snap expects revenue of as high as $435 million in Q3, sharply above analysts’ consensus outlook of $400 million. Its EBITDA is expected to improve to -$85 million to -$60 million, compared with -$138 million last year. Increasing advertising revenue will help Snap achieve profitability eventually. In Q2, thousands of advertisers uploaded their product catalogs to Snap. In effect, the company expects these e-commerce ads to meaningfully accelerate its revenue growth in the second half of the year.

Snap is helping advertisers achieve measurable, improving ROI. In Q2, it implemented deep learning models to give marketers  tools to make predictions. As usage of those products grows, advertisers will benefit from more ads getting to their intended audience. Snap said that when it started using the new deep learning model to boost app installation, it benefited from 20% more installs with fewer ads shown.

Growth Opportunity

More advertisers are joining Snap’s marketplace. As the marketplace’s diversity increases, the company’s advertising revenue will rise. Snap is driving demand in three ways. First, it is supporting integration with third-party channels like Shopify (NYSE:SHOP). As a result, marketers will have an easier experience measuring and managing campaigns. Second, it is finding ways to make self-service tools easier. And third, Snap is launching products and partnerships whose primary objective is help attract more advertisers.

Snap’s content business is another growth opportunity. By improving its content and investing in personalization over the last few quarters, the company is finding new ways to monetize content. Increasing engagement with its original shows enables the company to run unskippable, 6-second commercials on them. And since users are staying on the app, Snap will continue to accelerate user monetization.

Investments in its augmented reality platform may boost Snap stock in the long-run. Snap launched the next generation of AR lenses that use deep neural networks. By using the lenses to modify people’s appearance in real-time, users get captivated with them. This will further drive user activity on the app.  A ramp up in investments in content and augmented reality should lead to long-term user activity growth. Additionally,  advertisers can run non-skippable video ads on AR lenses.

Price Target and the Bottom Line on Snap Stock Price

If investors believe Snap’s  revenue can rise at a compound annual growth rate of about 17% over the next ten years, then Snap stock is still trading at a slight discount. In a 10-year DCF Revenue Exit model, assume a terminal revenue multiple of between seven and eight. Per finbox.io, using that multiple, SNAP stock is worth around $18.70.

Snap may have lost money again in Q2, but its free cash flow is improving and the dilution of Snapchat stock  is moderating. As the company finds innovative ways to improve its product, users will flock to the app. Advertisers will, in turn, follow the users and will justifiably raise their ad spending budgets, boosting Snap’s profits and Snapchat stock.

As of this writing, the author did not hold a position in any of the aforementioned securities.

Chris Lau is a contributing author for InvestorPlace.com and numerous other financial sites. Chris has over 20 years of investing experience in the stock market and runs the Do-It-Yourself Value Investing Marketplace on Seeking Alpha. He shares his stock picks so readers get actionable insight to achieve strong investment returns.


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