Snap Inc. (NYSE:SNAP), the camera application and software app company, just had its first full year of positive free cash flow (FCF). But SNAP stock is still down 36.4% year-to-date (YTD) as of Apr. 25, at $29.91. This is down from $47.03 at the end of last year. In other words, the market is still not that sure about the stock. However, if it keeps producing positive FCF as it did last quarter and last year, things could change. But there are headwinds that could affect its valuation.
Snap reported stellar fourth-quarter (Q4) and 2021 earnings on Feb. 3. The company is now profitable after losses in Q3 mainly due to the effects of the Apple (NASDAQ:AAPL) iOS advertising changes. This could push SNAP stock significantly higher from here. In Q4, revenue rose 42% to $1.3 billion from a year earlier. In addition, its adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) almost doubled to $326.7 million in Q4 2021.
Analysts now forecast that sales will rise 49% to $1.22 billion this quarter from $845 million in Q1 a year ago. Moreover, for the full year, they forecast earnings per share (EPS) of 53 cents this year, up slightly from 50 cents last year. But for 2023, the average estimate of 29 analysts surveyed by Refinitiv is for EPS of $1. This is twice the level of 2021, implying a compound annual growth rate (CAGR) of 41.4% over both 2022 and 2023. That is likely a direct result of its profitability.
Issues With SNAP Stock and its Valuation
The only problem I see here is that ad rates and advertising revenue for SNAP could drop significantly if the economy hits a major snag. Companies that rely on advertising revenue typically suffer during recessions. This is the kind of expense that major corporations cut out first during a downturn. In addition, it is not clear that young people will keep up their usage of Snap Inc. during a downturn.
As a result, investors should take some caution here. Look carefully at what the company says it projects from its ad customers going forward. If they indicate that sales are still strong and usage of Snap by millennials is not fading, this might be a good price. For example, Morningstar reports that the price-to-sales (P/S) multiple for SNAP stock in the last five years has been over 21 times. Today, according to Yahoo! Finance, it is at 10x. That might mean it is a bargain from a historical standpoint.
But you can’t drive looking backward. The truth is that a P/S multiple of 10x will be very vulnerable if the economy hits a severe recession. The Federal Reserve is intent on slowing the growth of the economy. That could hit Snap’s revenue growth and lower its valuation metrics even further. It is best to wait and see with SNAP stock and watch for its reporting for Q1.
On the date of publication, Mark Hake did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
