Shares of social media company Snap (NYSE:SNAP) went parabolic in the first half of 2019, with Snapchat stock essentially tripling from $6 in January to $18 by July. Ever since, though, the shares have gone quiet. Into the end of 2019, all SNAP stock did was bounce between $13 and $17, without staging any meaningful breakout higher, or fall lower.
This sideways trading won’t continue forever. Expect Snapchat stock to start moving again into 2020. And, when it does, it will likely breakout higher to prices above $20.
My relative bullishness on Snapchat stock boils down to three things: The digital ad market will have a strong 2020, pushed by recovering economic growth and political ad spend. Continued international growth, product innovation, and content expansion will ensure that Snap’s usage trends remain healthy in 2020. Finally, the valuation underlying Snapchat stock leaves room for sizable share price appreciation over the next 12 months.
All in all, SNAP stock looks like a good digital ad-fueled stock to buy-and-hold for 2020.
Digital Ad Market is Improving
The first big reason to like Snapchat stock in 2020 is that the digital ad market will have a strong showing, and Snap is attractively positioned in that market.
Ad spending trends are tied closely to economic strength and confidence. That is, when the economy is doing well and corporate leaders are confident, companies up their ad spend budgets. Similarly, when the economy is not doing well and corporate leaders are losing confidence, companies cut their ad spend budgets.
In 2019, ad spending trends slowed because the economy slowed at the rumble of U.S.-China trade war escalation. Now, that trade war is de-escalating, and looks set to continue to de-escalate into the 2020 U.S. presidential election. If so, the economy — which is already in rebound mode — will continue to recover. As it does, companies will accelerate their ad spend.
Also of note, 2020 U.S. ad spend will get a big boost for political ads. Importantly, a lot of digital ad giants have been under fire for the way they handle political ads, and Twitter (NYSE:TWTR), Alphabet’s (NASDAQ:GOOGL) YouTube, and many others have either entirely banned political ads and/or cracked down on political ad usage. Snap hasn’t been under fire, and they remain open to political ads. Therefore, Snap is attractively positioned to win a bunch of political ad dollars in 2020.
Against this favorable ad backdrop, Snap’s revenue growth rates in 2020 should remain robust, and that sustained growth should provide support for further gains in SNAP stock.
Snap Continues to Innovate
The second big reason to like Snapchat stock in 2020 is that management continues to innovate at an impressive pace, and this sustained innovation lays the groundwork for sustained user growth over the next several quarters.
Snap’s innovation comes in three parts — product, content, and access. On the product front, Snap just released Cameos, a feature where you can replace the face of people in videos using selfies. This is a big deal. The company’s last major product innovation, the face-swap filter, was a big driver of impressive user growth early in 2019. Cameos has a chance to replicate that success. If it does, impressive user growth in early 2020 could provide a boost to Snapchat stock.
On the content front, Snap recently announced a partnership with UFC, which will bring a ton of original UFC content to the Snapchat platform. This, too, is a big deal. One of the reasons Snap regained user growth momentum in 2019 was because the company aggressively populated its Discover section with original content. The more the company does this, the more likely Snap retains that momentum.
Meanwhile, with respect to access, Snap continues to make international access to its app easier, through Android app improvements and a heavier focus on international markets, including India.
Connecting all the dots, a healthy innovation curve at Snap will enable the company to sustain healthy user growth trends in 2020, which should also provide support for further gains in Snapchat stock.
Snapchat Stock is Undervalued
The third big reason to like Snapchat stock in 2020 is that shares are undervalued relative to the company’s long-term profit growth potential.
Thanks to product and content innovation as well as international expansion, Snap will continue to add 10 to 20 million new users per year over the next several years. That gives the platform visible runway to 300 million daily active users by 2025.
Unit revenue rates should run higher, too, thanks to increasing reach and better ad tools. Importantly, those unit revenue rates are depressed today, at around $2 per user versus $5-plus rates at most other major social media companies. By 2025, this gap should be closed, at Snap should be up above $5 in terms of quarterly average revenue per user.
Assuming so, I think Snap reasonably projects as ~25% revenue grower into 2025, with revenues hitting somewhere around $7 billion by then.
Gross margins should continue to improve towards the digital ad industry-average rate of roughly 80%. Expense growth rates will remain relatively muted next to big revenue growth, and positive operating leverage will continue to drive the opex rate down towards a more normal 40% at scale. Thus, by 2025, Snap could very easily be at 40% operating margins with nearly $7 billion in revenue.
Under those assumptions, my modeling suggests that 2025 earnings per share will come out to $1.50. Based on a information technology sector-average 22-times forward earnings multiple and a 10% annual discount rate, that equates to a 2020 price target for SNAP stock of nearly $23.
Bottom Line on SNAP Stock
SNAP stock was red hot in the first half of 2019. It has gone quiet ever since. In 2020, Snap should regain the growth momentum it had in the first half of 2019. As it does, Snapchat stock should shoot above $20.
As of this writing, Luke Lango did not hold a position in any of the aforementioned securities.