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Snap: Growing, but is Valuation Unrealistic?
Stock Analysis & Ideas

Snap: Growing, but is Valuation Unrealistic?

Snap (SNAP) is a camera company, founded on the belief that reinventing the camera represents the mightiest opportunity to upgrade the way humans live and communicate.

This rather bold statement includes empowering people to live in the moment, learn about the world, and have fun together.

Snap’s flagship product, Snapchat, is a smartphone app utilized by millions of people. The company has seen accelerated growth in its user base over the past couple of years, and financials have followed suit by growing higher.

That said, I am hardly convinced of the stock’s valuation, as Snap is likely overvalued. For this reason, I currently remain neutral on the stock.

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Positive Expansion, Steep Valuation

Snap’s growth had started showing signs of slowing down a couple of years back.

In Q2 2020, revenue growth had fallen to as low as 17%. However, in the midst of the pandemic, the company took the opportunity to expand its demographic reach by focusing on Snapchat’s capabilities as a content platform, digital ad market, and augmented reality platform.

Simultaneously, user growth accelerated during the pandemic, due to the increased need for people to communicate virtually.

In Q2 2021, one year after Snap’s underwhelming growth as mentioned earlier, revenues grew 116% year-over-year, to $982 million.

With the company now attracting larger advertiser interest following its initiatives and higher user base, the average revenue per user (ARPU) grew 76% year-over-year to $3.35 for the quarter. This metric is likely to continue growing higher, as Snapchat pivots towards higher-age demographics, further contributing to higher revenues going forward.

While the company is highly scalable, gross margins sit at around 55%, leaving limited room for a juicy bottom line. Facebook (FB), for context, enjoys gross margins of 80%. In fact, Snap has never posted a single profitable quarter since its inception.

For this reason, it seems that investors have almost no margin of safety at Snap’s current valuation. The stock is currently trading at 22.4x its next-12 month (NTM) revenues, which is hardly justifiable.

Even if we assume the company doubles revenues next year and achieves a 10-15% net income margin, this multiple would still make little sense.

Snap’s performance would need to remain stellar for at least a few years to justify the current valuation. In the meantime, if any significant risk arises (e.g. a new competitor capturing market share, user base growth maturing, etc.), investors could easily trade the stock lower towards a more reasonable valuation, leading to significant losses from the stock’s current price levels.

Wall Street’s Take

Turning to Wall Street, Snap has a Moderate Buy consensus rating, based on 26 Buys, seven Holds, and one Sell assigned in the past three months. At $87.47, the average Snap price target implies 19.2% upside potential.

Disclosure: Nikolaos Sismanis did not have a position in SNAP shares at the time of publication, but had a beneficial long position in the shares of FB through stock ownership.

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