Snap (NYSE: SNAP) stock has fallen more than 20% this year. In fact, the stock has decreased over 50% from its peak in July of last year. It was trading at around $8 per share at the close of the market yesterday. This recent poor performance can be linked to the absence of second-quarter guidance, worries about how macroeconomic conditions are impacting advertising demand, and slower-than-expected revenue growth, particularly in key segments. The current question is – could it decline further—by another 25-30%? What if it drops to 50%, reaching $4 levels?
Well, here’s the issue: even at about $8 per share, the stock isn’t inexpensive. It is valued at nearly 35 times its cash flow over the last twelve months. If we invert that figure, it results in a cash flow yield of roughly 2.9% (the ratio of cash flow to price). By comparison, Meta Platforms trades at just 17 times cash flow. Furthermore, Meta is a leader in social networking platforms and has consistently achieved 13% revenue growth over the past few years, in contrast to 9% for SNAP. Is a 35x multiple genuinely warranted for SNAP? What you are willing to pay is significant. We have developed the Trefis High Quality Portfolio with a focus on relative valuation. Notably, HQ has recorded over 91% return since its inception and has outperformed the S&P, Nasdaq, and Dow — all of them. Separately, see – Nvidia Stock’s 1 Big Risk
Why Is SNAP Expensive?
Although Snap’s average revenue growth of 9% over the past three years is relatively modest, and its -13% net margins are inferior to most companies in the Trefis coverage universe, there’s a crucial factor influencing its valuation. Snap has notably increased its user base, with daily active users rising from 319 million in 2021 to 460 million currently. This steady user growth has historically been rewarded by the market.
The company’s appeal to advertisers comes from its primary target audience: younger demographics (Gen Z and Millennials). These groups are particularly appealing due to their significant future spending potential and engagement with emerging trends, prompting investors to pay a premium for access to this valuable audience.
What’s Next for SNAP?
While Snap may continue to grow its user base in the short term, the critical challenge lies in enhancing its Average Revenue Per User (ARPU). Failure to achieve this could result in a slowdown in revenue growth. Moreover, the company is currently not profitable, and the necessity to integrate AI into its offerings may further strain its already tight margins.
As a result, Snap’s valuation should reflect that of companies experiencing 5-10% revenue growth, assuming it can even maintain that level.
In stark contrast to Snap, Meta is a more stable, resilient, and deeply entrenched entity. Its dominance is “embedded” in the essential ways people socialize, communicate, and consume digital content. Meta currently trades at about 17 times cash flow while delivering 13% annual growth. If Snap were valued at a comparable 17x cash flow multiple, its share price would drop to around $4, representing another 50% decline.
Could Snap’s multiple even fall below the 17x commanded by Meta? Ultimately, the choice of how much you are ready to pay for SNAP is up to you.
Why It May Still Be Okay – And Not A Time To Panic
Snap’s dependence on digital advertising, especially from sectors like consumer goods, entertainment, retail, and tech services, offers a potential silver lining. There’s always the chance that advertising expenditures will recover. Historically, when economic conditions improve and consumer confidence rises, marketing budgets are among the first to expand. This occurs because companies typically increase advertising spending when they’re optimistic about future sales growth, planning new product launches, or actively competing for market share.
If advertising activities and volumes increase, Snap’s revenues are likely to follow. There’s considerable pent-up demand from brands that scaled back their advertising efforts during recent economic uncertainty. Importantly, Snap may not need to significantly elevate its ad prices; it mainly requires a boost in advertiser activity to drive its revenue growth.
Balancing Risk-Reward
Comparing SNAP with Meta is essential for understanding the risk-reward profile of investing in Snap. Effective investment decisions rely on gauging relative attractiveness. The central question is: should you invest in SNAP stock, maintain interest-earning cash to avoid market risk, or perhaps choose an S&P 500 ETF? How much higher is the expected return on SNAP stock compared to cash, and what downside risk must be accepted for that potential gain?
Utilizing a specific “anchor” asset like Meta Platforms provides a strong framework for assessing this risk-reward dynamic.
Note: Choose comparisons wisely. SNAP is currently a “high valuation” stock. When a company trades at around 35x Price-to-Free Cash Flow (P/FCF), anchoring it against Meta offers essential perspective. Meta, with more reasonable multiples, often makes a more compelling investment case than Snap.
Regardless of the trade-off, investing in a single stock can be risky. Conversely, the Trefis High Quality (HQ) Portfolio, comprising 30 stocks, has a proven track record of comfortably outperforming the S&P 500over the last 4 years. What accounts for this? As a collective, HQ Portfolio stocks have delivered superior returns with reduced risk compared to the standard index, with a more stable performance observable in HQ Portfolio performance metrics.
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