Q3 Numbers Show Exactly Why Snap Stock Remains a Long Term Winner

Snap (NYSE:SNAP) rocketed higher by more than 30% in late October, Snap stock popped after the social media company reported third quarter numbers that smashed estimates across the board.

Snap Shares Are Volatile but the Chart Looks Good Heading Into 2020
Source: dennizn / Shutterstock.com

User numbers topped expectations. So did revenues. And margins. And profits.

It was a monstrous quarter wherein everything came in miles ahead of expectations, and which broadly underscored that Snap is absolutely killing it in the red-hot digital advertising category today.

I don’t see this dynamic ending anytime soon. Instead, social media engagement and digital ad dollars will both continue to grow.

Snap will continue to lean into innovation, new product features and geographic expansion to increase its chokehold on the global Generation Z demographic. Huge growth will continue to drive positive operating leverage throughout this highly scalable digital advertising business model.

Users. Revenues. Margins. Profits. All of those numbers will continue to look great for the foreseeable future.

So stick with SNAP stock. The company is killing the game right now. So long as that remains true, the stock will keep pushing higher.

A Monstrous Quarter for Snap Stock

There’s really no other way to put it. From top to bottom, Snap’s third quarter earnings report was as good as it gets.

Daily active users rose 19% year-over-year, with net adds in the quarter coming in at 11 million. That’s largely consistent with what the company has done over the past few quarters, implying that even as Covid-19 restrictions were lifted throughout the summer, young consumers remained as addicted as ever to Snap.

Average revenue per user rose 29% year-over-year — the best ARPU growth rate in a year — broadly underscoring that advertisers are once again advertising, but that they are all rushing into the digital channel more than ever before.

A resurgence in ad spending coupled sustained momentum in engagement led to Snap reporting 52% revenue growth, the company’s strongest revenue growth rate since the first quarter of 2018. So, for all intents and purposes, scale isn’t slowing Snap down. This growth narrative is only accelerating.

Moving further down the income statement, gross margins continued on their upward trend towards 80%, rising seven points year-over-year. Operating expenses rose just 25% year-over-year — versus 52% revenue growth — allowing for a 10 point drop in the opex rate.

Across the board, the numbers were simply perfect. You got sustained robust user growth, coupled with record high revenue growth and continued rapid profit margin improvement.

I’m not sure there’s any such thing as a “perfect” earnings report. But Snap’s Q3 earnings report was as close as you will ever find — and that’s why SNAP stock has soared over 30% in response to all time highs.

Innovation Driving Growth

Importantly, Snap’s record third quarter earnings report was driven by a sustainable driver: innovation.

Specifically, Snap is relentlessly innovating across its whole business — from product to ad platform — to rapidly accelerate its value prop to both consumers and advertisers.

On the consumer side, Snap has leaned heavily into original content, augmented reality and cross-app integration to turn Snap from a photo-sharing app, into an all-in-one visual entertainment hub for young consumers.

These efforts are paying off. Snap Shows watch time increased 50% in the quarter. The company’s original series “VS The World” racked up 14 million viewers. A new “Anime Style” AR lens was engaged with 3 billion times in the first week. Headspace Mini was used by 5 million users in its first month after launch.

Most of these initiatives are still in their early stages. As they develop and mature over the next few years, Snap’s user growth trajectory will remain robust, and more and more users will spend more and more time on the app than ever before.

Meanwhile, on the advertising side, Snap has dramatically improved its ad product over the past few months. These improvements include the launch of AR-powered virtual try-on experiences for retailers, a new ad mechanism called Bursts which allows advertisers to rapidly reach their target audience, and a new business-to-business marketing campaign dubbed “Meet the Snapchat Generation” which highlights the platform’s unique demographic.

These ad product improvements are clearly working. Revenue growth just hit a two year high. More importantly, these ad product improvements — much like the consumer product improvements — are mostly still in their early stages, which means that there is significant visibility to Snap sustaining robust revenue growth on top of robust user growth over the next few years.

Zooming out, Snap’s third quarter earnings report wasn’t an anomaly. Because it was driven by a sustainable growth driver that is still in its early stages — innovation — Snap is on track to report many more quarters like this over the next several years.

Snap Is Not Overvalued

The one big knock against SNAP stock up near $40 is valuation.

After all, this is now a $55 billion company positioned to do about $2.2 billion in sales this year. Ostensibly, that comparison does make SNAP stock look wildly overvalued.

But the “overvalued” thesis is short-sighted. You don’t value a hypergrowth stock in the first few innings of its growth narrative by looking at this year’s sales. You value it by looking at where the company will be 10 years down the road.

When you do that, it becomes clear that SNAP stock is not overvalued today.

Snap is on a breakneck growth trajectory to expand its user base from ~250 million daily actives today, to probably somewhere around 500 million daily actives by 2030, thanks to geographic expansion and new and compelling product features.

Quarterly average revenue per user — which sits at just $2.73 today — will rise towards $10+ by 2030, on the back of continued ad product improvements, an accelerated shift towards digital advertising and rising demand for Snap ad inventory.

Put all that together, and you’re talking a ~$20 billion revenue company by 2030. Assuming Snap scales towards more normal profit margins for mature digital ad companies, then my modeling says that $20 billion in 2030 revenue will flow into somewhere around $4 in earnings per share.

Social media stocks tend to trade at 20-times forward earnings. Based on a 20-times forward multiple, $4 in 2030 EPS implies a 2029 price target for SNAP stock of $80. Discounted back by 8.5% per year, that implies a 2020 price target for SNAP stock of just under $40.

So, no, SNAP stock is not overvalued. It’s fairly valued.

Bottom Line on SNAP

Snap’s monster third quarter earnings report underscores that this company is killing the digital advertising game at a time when the digital ad sector is red-hot.

Against that backdrop, the only reason you’d want to sell SNAP stock is if it was wildly overvalued.

But it’s not. It’s fairly valued.

So, the takeaway is crystal clear. So long as Snap keeps killing the game and the valuation remains tangible, stick with SNAP stock.

On the date of publication, Luke Lango did not have (either directly or indirectly) any positions in the securities mentioned in this article. 

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