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This article originally appeared on Simply Wall St News.
Snapchat’s parent company Snap Inc. ( NYSE:SNAP ) has been a surprise outperformer since the platform was all but written off shortly after its IPO . Back in 2018 and 2019, the financial media was littered with articles about Snap’s impending demise . The stock price fell over 75% within two years of the IPO. The sell-off was prompted by stagnant user growth, staff turnover and concerns about the number of similar platforms competing for attention.
The stock price bottomed at $4.82 in December 2018, and has since risen more than 1,300%. The turnaround has been partly attributed to worldwide lockdowns which have increased the amount of time consumers spend online. But, user numbers have actually been increasing steadily since the platform was redesigned in 2019. Snapchat has also become wildly popular amongst consumers in the highly engaged 18 to 29 age group .
Snap continued to prove its critics wrong when it reported second quarter results last week. The company reported a loss per share of $0.10, well ahead of the expected $0.18 loss per share. Quarterly revenue of $982 million was also $135 million ahead of consensus estimates. Snap has now beaten expectations for EPS and revenue in 11 of the last 12 quarters. The number of active users at 293 million was also 3 million higher than expected in the last quarter.
Is Snap overvalued?
Last week's earnings surprise led to a 24% jump in the share price. This means that while the company is still not profitable, its market capitalization is 29 times the revenue it has earned over the last 12 months.
If you are a shareholder or a potential investor you may be wondering if the stock is now overvalued. Whether the stock is over or undervalued will depend on your assumptions for Snap’s future growth. When assessing the valuation, a good starting point is to get an idea of the growth rate required to generate a return from the current price.
Our valuation model, which is based on analyst estimates, suggests the intrinsic value is about $63.79. The current share price of $76.32 is 19.6% higher, which isn’t particularly excessive for a rapidly growing company. More important is how the company performs relative to the growth rates implied by the share price.
Can we expect growth from Snap?
Current forecasts are for revenue growth of 68% this year, and 45% in the next two years. To put that in perspective, year on year revenue growth has averaged 48% over the last 8 quarters, though it did accelerate to 74% in the last quarter. So, the forecasts imply that there won’t be a significant slowdown in the future.
The profit margin is forecast to improve to 14% by the end of 2023. This appears realistic as long as expenses rise at a slightly lower rate than revenue growth.
Future outlook is an important aspect when you're looking at buying a stock, especially if you are an investor looking for growth in your portfolio. Although value investors would argue that it's the intrinsic value relative to the price that matters the most, a more compelling investment thesis would be high growth potential at a cheap price.
There may be a better opportunity to buy low in the future? Given that Snap's share is fairly volatile (i.e. its price movements are magnified relative to the rest of the market) this could mean the price can sink lower, giving us another chance to buy in the future. This is based on its high beta, which is a good indicator for share price volatility.
What this means for you:
Are you a shareholder? It seems like the market has well and truly priced in SNAPs positive outlook, with shares trading above its fair value. At this current price, shareholders may be asking a different question: should I sell? If you believe SNAP should trade below its current price, selling high and buying it back up again when its price falls towards its real value can be profitable. But before you make this decision, take a look at whether its fundamentals have changed.
If you decide to hold the share, you may want to monitor Snap's growth rates each quarter to make sure the company is still on track.
Are you a potential investor? If you've been keeping an eye on SNAP for a while, now may not be the best time to enter into the stock. The price has surpassed its true value, which means there's no upside from mispricing. However, the optimistic prospect is encouraging for SNAP, which means it's worth diving deeper into other factors in order to take advantage of the next price drop.
Snap is trading at a modest premium based on analyst forecasts, but those forecasts do imply the company can keep growing revenue at over 40% a year. That's certainly not impossible, but it is quite a high bar. Of course, if you believe the company can grow faster than expected, the current price may be a bargain.
So if you'd like to dive deeper into this stock, it's crucial to consider any risks it's facing. For example, we've discovered 3 warning signs that you should run your eyes over to get a better picture of Snap.
If you are no longer interested in Snap, you can use our free platform to see our list of over 50 other stocks with a high growth potential.
Simply Wall St analyst Richard Bowman and Simply Wall St have no position in any of the companies mentioned. This article is general in nature. It does not constitute a recommendation to buy or sell any stock and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.