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Wait for a Correction to Buy Snap Stock

Ian Bezek

Snap (NYSE:SNAP) was one of the biggest winners in social media in 2019, with its shares nearly tripling. After a dreadful downturn following its IPO, Snap enjoyed the same sort of turnaround that other social media networks did. Don’t rush to conclude that Snap will eventually have the same success that, say, Facebook (NASDAQ:FB) did, however.

Snapchat Stock Won't Top $20 This Year, but It's a Good Buy on the Dip

Source: Ink Drop / Shutterstock.com

Snap still faces a ton of challenges, including inconsistent user growth, a lack of profitability and relatively low revenue generation per user. At $6 per share, investors had largely given up on Snap’s story. Up here at $19, the risk and reward are more fairly balanced.

On top of that, CEO Evan Spiegel is selling large quantities of stock, including a $50 million sale this week. Should you join him in ringing the register?

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Snap’s Bull Case

Given the big run-up in Snap shares last year, it’s worth asking what folks still see in the stock. At 17x sales and still losing money on an earnings basis, people aren’t buying Snap stock for its strong profitability or cash flows.

Rather, there’s the excitement that Snap seems to be turning the corner. The company has done a better job of monetizing users. And, bulls argue, potential weakness at the dominant ad companies such as Alphabet (NASDAQ:GOOG, NASDAQ:GOOGL) and Facebook give Snap an opportunity. For years, investors have been speculating on which platform would become the solid No. 3 player in the industry. Twitter (NYSE:TWTR) has seemingly squandered its chance to seize that position, and it’s left the door open for Snap. So far, Evan Spiegel and his team have been executing on that opportunity.

AI Factory

Earlier this month, Snap announced that it is buying AI Factory, a firm based out of Ukraine that focuses on video-editing technologies. Specifically, AI Factory helped with the creation of Snap’s new Cameos feature that allows users to turn their selfies into animated short videos.

Snap has enjoyed tremendous success pioneering photo lenses and filters, and is betting that giving this sort of creativity to short videos will help drive more user engagement and create additional types of advertising opportunities. Other players such as TikTok are reportedly working to create videos from user selfies, so Snap is also taking a decisive step to stay ahead of the curve there.

Questions About AI Factory

One thing worth considering is that this AI Factory purchase may affect Snap in another way. $166 million is a large enough price tag that Snap will probably report adjusted earnings numbers that take this merger into account. As such, particularly if Snap reports softer-than-expected earnings, it may be able to divert attention from the numbers by saying that the figures aren’t comparable due to the acquisition.

This could help Snap stock in the short run, particularly if earnings come in soft. Over the long term, however, make sure to double check whether things such as reported EBITDA and cash flow figures are as good as they may seem once you account for accounting adjustments from the merger.

There’s also a related parties concern to consider with AI Factory. AI Factory was founded by Victor Shaburov. Shaburov and Snap already had history together. According to TechCrunch, Snap acquired Shaburov’s previous company, Looksery in 2015, and Shaburov became a director of engineering at Snap. Then, Shaburov left Snap to co-found AI Factory in 2018. Less than two years later, Snap had to pony up $166 million to acquire Shaburov’s latest company. This seems like an expensive way to deal with a key employee and innovator.

The Bottom Line on Snapchat Stock

Recently, InvestorPlace’s Thomas Niel concluded that Snap’s stock is already priced for perfection, and wrote:

“So what’s the call? Consider a buy if the SNAP stock price dips. At current prices, there’s not enough upside to compensate for underlying risks.”

I agree with Niel’s take. Snap has the ability to power up to $20 and potentially past that if ad spending continues to grow at a decent clip. But don’t count on 2020 to be anything like 2019 for Snap stock — it will be a much tougher climb this year. And with shares already having tripled off the lows, it wouldn’t take much for traders to want to start locking in profits on Snap if anything goes wrong.

I know it’s tempting to want to grab speculative stocks like this. The market is on fire, and Snap could take off like so many other hot names. But I’d urge you to be cautious. There will almost certainly be a better moment to buy Snap and other low-profitability tech companies once a correction hits.

At the time of this writing, Ian Bezek owned FB stock. You can reach him on Twitter at @irbezek.

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