Snap (NYSE:SNAP) stock has seen tremendous gains this year. Shares have soared from $5.38 on Jan. 2 to $16.62 at the close Sept. 6. Shares now trade at a substantial premium to social media peers Facebook (NASDAQ:FB) and Twitter (NYSE:TWTR). But is this valuation justified? Snap posted strong earnings on July 23. But the company remains a social media also-ran.
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With these factors in mind, the SNAP stock price could easily “snap” lower. But as story stocks continue to rise, SNAP could rally higher.
Read on to see why investors should look elsewhere for opportunity.
The Current SNAP Stock Price
SNAP stock has stagnated since its July earnings release. But investors continue to give the company a premium valuation. With high expectations, what does Snap have in the cards to boost the share price? Mobile gaming could be the catalyst that sends shares higher. Evercore ISI’s Kevin Rippey thinks so. The analyst upgraded Snapchat stock to “Outperform” on the company’s future gaming prospects. Mobile gaming could generate $350 million in annual revenue by 2022.
But does this growth potential explain the current valuation? As InvestorPlace contributor Vince Martin wrote on Aug. 21, Snap needs massive growth to justify the current share price. By Martin’s calculation, Snap needs to boost revenues by 40% just to break even. Even greater levels of growth are required for the company to “grow into its valuation.”
A new revenue stream could help inch Snap closer to profitability. But at the current valuation, is this opportunity worth the risk? Other social media properties are seeing growth slow. But they have the profitability Snap doesn’t have. Let’s compare SNAP stock to Facebook and Twitter, and see whether SNAP stock is a unique opportunity.
SNAP Stock Trades at a Premium
Using the enterprise value/sales metric, Snapchat stock trades at a large premium to Facebook and Twitter. Facebook shares trade at an EV/Sales ratio of 8.1. Twitter shares trade at an EV/Sales ratio of 9.6. But perhaps this premium is justified. Facebook’s forward growth is 19%; Twitter’s is 28.1%. With projected growth of 40% over the next year, SNAP stock may be worth the premium. But, at some point, growth must translate into profits.
Snap may be able to continue riding the growth train. Nomura analyst Mark Kelley estimates Snapchat’s user base could grow by between 5.5 million-10 million users this quarter. This is double Snap’s projections of 2.5 million-4 million new users. This could indicate Snap’s future growth prospects are higher than anticipated. Snap has not provided a date for the next earnings report. But based on historical trends, the next release date should be in late October.
No matter the outcome, Snap needs continued high growth just to sustain its valuation. Any hiccup could devastate the SNAP stock price. What are the biggest risks? The much-anticipated recession could hurt ad revenue. A decline in digital ad spending would impact Facebook and Twitter. But given Snap’s “also-ran” status, it could see a greater negative impact.
Competitive pressure from Facebook is another risk. In the past, Facebook dropped the ball attracting Generation Z. With the unique Snapchat platform, Snap captured the zeitgeist of a rising generation. But Facebook is quickly regaining relevancy with the “Snapchat generation.” Facebook’s Threads app offers Snapchat-esque features within the Facebook universe.
Bottom Line: SNAP Stock Priced for Perfection
Snapchat stock has seen big gains since January. But the company needs to meet expectations with results. Revenues are now over $1 billion per year. But can it continue growing revenue at a 40% clip? The company’s move into gaming could help better monetize its user base. But Facebook is quickly catching up with new apps and features. This could reduce Snapchat’s popularity among Generation Z.
I do not want to be a SNAP bear. Given the strong performance of high-fliers such as Shopify (NYSE:SHOP) and Roku (NASDAQ:ROKU), all bets are off with large-cap growth names. A market correction could bring valuations back down to earth. But if the party continues for another year, the SNAP stock price could rally higher.
But this is more of a speculation than a true investment. The fundamentals indicate SNAP stock is overvalued. Stay on the sidelines with Snapchat stock. Look for more solid opportunities elsewhere.
As of this writing, Thomas Niel did not hold a position in any of the aforementioned securities.
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