Snap (NYSE:SNAP) reports second-quarter earnings on Thursday, Aug. 10. Like all ad-supported social media companies, investor attention will naturally gravitate toward user growth -- or lack thereof. Twitter (NYSE:TWTR) was recently punished for posting flat sequential monthly active user (MAU) growth, for instance. While Snap does not disclose MAUs, it does disclose daily active users (DAUs) as its sole user metric.

Like many freshly public companies, Snap's first public earnings release was marred by massive stock-based compensation expenses tied to the IPO and a huge bonus that CEO Evan Spiegel earned by taking the company public. Those one-time costs won't affect second-quarter results, so Snap investors should get a clearer look at the company's performance and cost structure.

Various social media apps on a smartphone

Image source: Pixabay.

Show me the money

Snap has yet to prove its core ad business, and has a long way to go before it can justify its lofty valuation. Even at all-time lows, Snap appears overvalued relative to both its larger and smaller peers. Facebook (NASDAQ:FB) is more expensive in terms of book value, but has largely proven to investors that it can execute. The same cannot be said of Snap.

Company

Price-to-Sales (TTM)

Price-to-Book-Value (MRQ)

Snap

29.6

4.1

Twitter

4.8

2.5

Facebook

14.8

7.4

Data source: Reuters. TTM = trailing-12-month. MRQ = most recent quarter.

It's also worth noting that Snap investors are currently pricing in optimistic growth expectations: Snap's market cap is larger than Twitter's and shares fetch higher valuation multiples, despite the fact that Twitter's TTM revenue base is five times as large.

More specifically, Snap's average revenue per user (ARPU) remains quite low, at just $0.90 in the first quarter. Facebook reported worldwide ARPU of $4.73 in the second quarter. Snap's ability to grow ARPU will be directly linked to any changes in the composition of its user base. This echoes Twitter's woes, as it lost 2 million MAUs in its core U.S. market where monetization is the strongest, but gained 2 million international MAUs that aren't monetized as well.

Snap Geographical Segment

Q1 DAUs

Q1 ARPU

North America

71 million

$1.81

Europe

55 million

$0.24

Rest of world

40 million

$0.19

Data source: SEC filings.

If Snap is able to muster up solid DAU growth, that won't mean as much if user growth comes from international markets -- i.e., those that Spiegel considers "poor countries."

But at what cost?

There's also the issue of hosting costs. Even if Snap is able to grow DAUs and ARPU, the company's cost structure is not designed to scale well since it is highly variable and primarily consists of usage fees for third-party cloud infrastructure and hosting. That fact will undermine any semblance of operating leverage in the near future. To be fair, the company has made some progress in this regard, thanks in part to renegotiating contracts with its two primary cloud vendors.

A year ago, Snap posted a negative gross margin because its hosting costs per DAU exceeded ARPU:

Chart comparing ARPU and hosting costs per DAU over time

Data source: SEC filings. Chart by author.

Keeping hosting costs in check will also be another important area for Snap investors to monitor closely when the company reports later this week.

Evan Niu, CFA owns shares of Facebook. Evan Niu, CFA has the following options: long January 2019 $20 puts on Snap Inc. and long January 2018 $120 calls on Facebook. The Motley Fool owns shares of and recommends Facebook and Twitter. The Motley Fool has a disclosure policy.