Shares of social media company Snap (NYSE:SNAP) surged nearly 20% in late July after the company reported strong second-quarter numbers which topped expectations across the board – from users to revenues to profits. This post-earnings rally continues what has been a year-long monster rally for SNAP stock. Year-to-date, SNAP stock has more than tripled, making it one of the hottest stocks in the entire market.

A lot of investors and analysts didn’t see this one coming. At the beginning of 2019, SNAP stock was being left for dead by investors. No one wanted to touch it because the platform was losing users, competition was heating up, and profits were a long way off.

Even overly optimistic Wall Street wasn’t too excited about SNAP stock. The consensus price target on the stock back in January 2019 was around $8.

Today, SNAP stock trades hands around $18, more than double its consensus price target from January.

What happened? How did SNAP stock go from big loser, to big winner? Let’s answer those questions by taking a closer look at five big reasons why the bears have been dead wrong about SNAP stock in 2019.

The User Growth Narrative Isn’t Dead After All

One of the core tenants of the secular bear thesis on SNAP stock is that this company’s user growth narrative is over.

Specifically, back in 2018, Snap’s user base started to fall back after several years of big growth. This user base compression coincided with the roll-out of Instagram Stories, Facebook Stories, WhatsApp Status, and other Stories-like features across the social media landscape.

Thus, the conclusion from many investors and analysts was that those apps were stealing Snap’s thunder, and that the platform’s user growth potential, in the long run, was going to be greatly hampered by competition.

Second-quarter numbers refuted that thesis in a big way. Snap added 13 million users quarter-over-quarter, the biggest volume of net adds since the second quarter of 2016. This mostly was because the company successfully reworked its Android app and saw huge growth in its international user base (which is predominantly Android-based).

Further, management guided for continued user growth in Q3, Q4, and 2020. Broadly, then, the “Snap’s user base is maxed out” thesis has been proven wrong, for now, and this renewed user growth trend has provided fuel for the big 2019 SNAP stock rally. 

Advertisers Are Increasingly Interested in Snap

Another core tenant of the bear thesis on SNAP is that the platform won’t be able to attract advertisers in bulk.

Specifically, Snap’s target demographic is niche and low income, which means that advertisers shouldn’t expect a huge return on investment from Snap ads. At the same time, within that demographic, Snap has less global reach than Instagram. Thus, if an advertiser needs to reach the global youth audience, they will likely turn towards Instagram, not Snap.

Again, though, the numbers this year refute the bear thesis. Snap has improved its advertising business and expanded its advertising capabilities in 2019. At the same time, the platform has returned to growing its user base. This combination has driven robust advertiser demand growth.

After rising by 37% or less throughout all of 2018, average revenue per user growth has risen by 37% or more in the first two quarters of 2019.

Thus, not only has user growth come back into the picture, but unit revenue growth has also accelerated in 2019 thanks to a pick-up in advertiser demand. This double tailwind has provided the fuel for above-consensus revenue growth throughout 2019. In turn, this above-consensus revenue growth has driven the stock materially higher.

Snap Has Differentiated Itself

In late 2018, many investors and analysts believed that Snap’s value prop of posting ephemeral media through Stories was undifferentiated in the social media landscape.

That is to say, you could do the exact same thing on any number of other platforms (Instagram, Facebook, and WhatsApp). Further, all those other platforms have more reach. Thus, the logical decision for consumers is to post a Story on Instagram, not on Snap.

But, that bear thesis has been deconstructed in 2019 by Snap’s ability to extend its value prop beyond the Stories niche.

Specifically, Snap has made three value prop extensions in 2019. First, Snap has extensively built out Discover to include original shows. It’s working. The Discover audience grew 35% year-over-year in Q2. The total time spent watching Discover content rose 60% year-over-year. Total time spent watching Shows more than tripled year-over-year.

Second, Snap has doubled down on augmented reality and filters. This is working, too. The volume of engagement with Lenses in Q2 exceeded the volume of engagement with Lenses in all of 2018.

Third, Snap has pivoted into mobile gaming. While there isn’t much data here yet, Snap’s venture into mobile gaming is yet another example of how this company is extending and differentiating its value prop in the crowded social media space.

Net net, Snap has changed over the past six months. They are no longer a Stories-only app. Instead, they encompass original shows, augmented reality, and mobile gaming. This value prop extension has enabled the platform to continue to grow users and engagement in the face of intense competition.

Margins Continue to Make Meaningful Progress

Another big knock against SNAP has been the company’s anemic margins and huge losses. Indeed, a year ago, this was a 30% gross margin company with a 94% operating expense rate. That combination ultimately produced an adjusted EBITDA loss of $169 million.

In 2019, however, Snap’s margin profile has improved meaningfully with scale.

In Q1, gross margins expanded 22 points year-over-year, the opex rate dropped back 35 points, and adjusted EBITDA loss narrowed from $218 million to $123 million. Q2 was more of the same. Gross margins expanded 16 points year-over-year. The opex rate fell 27 points. Adjusted EBITDA loss narrowed from $169 million to $79 million.

Thus, as Snap has gotten bigger, the company’s profitability profile has improved dramatically. Snap now reasonably projects as a 50%-plus gross margin company with an opportunity to drive the opex rate down to 30-40% over time. That combination means that Snap projects as a profitable company in the not-too-distant future.

As the outlook for profitability has gained clarity in 2019, SNAP stock has rallied.

The Broader Market Backdrop Has Been Favorable

It is important to not underestimate the role of the favorable market backdrop in SNAP’s epic 2019 rally.

Specifically, in 2019, rates have plunged. As rates go lower, that helps support more risk-on attitudes from equity investors (since bonds are yielding such poor returns). Lower rates also inflate the theoretical present value of future cash flows by pushing down the discount rate on those cash flows.

Thus, low rates have been a great thing for all stocks – and specifically growth stocks – in 2019.

SNAP stock is no exception. This is a stock that is valued entirely off of future profits, mostly because there are no profits today. Thus, as rates have plunged in 2019, the present value of Snap’s future profits has gone up, and this dynamic has provided a strong undercurrent for the 2019 rally in SNAP stock.

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