Most people agree Warren Buffett is a pretty good investor. He also has a way with metaphors. One of my favorites combines two things I love: stocks and baseball.
"The stock market is a no-called-strike game. You don't have to swing at everything -- you can wait for your pitch." If determining a company's value is too difficult, you don't have to buy or sell the stock. Just "take the pitch."
So, when BTIG analyst Rich Greenfield wrote he has a "complete lack of comfort" with his Snap (NYSE:SNAP) forecast, I was reminded of that Warren Buffett quote. And if the guy whose job it is to determine the value of Snap stock is uncomfortable with how he's valuing the company, it's probably a pitch you shouldn't swing at.
Why is Snap so hard to judge?
Snap has a lot of desirable traits. It has a highly engaged audience of young people using its app. It's one of the few alternatives to Facebook (NASDAQ:FB) and Google, the Alphabet (NASDAQ:GOOGL) (NASDAQ:GOOG) subsidiary, for digital advertisers. And it has a visionary founder and CEO at the helm.
At the same time, Snap's ability to execute is still questionable. Management has said its only competitive advantage (and anyone's in the digital space, for that matter) is its ability to innovate. And while it's made several interesting new product features since coming public, they haven't translated into better than expected revenue or user growth. In fact, results on both metrics have disappointed investors so far.
One of Snap's biggest efforts to scale its revenue generating products -- a self-serve ad platform -- actually caused its average ad price to decline while marketing expenses as a percentage of revenue increased. Management expects that to be a short-term, self-correcting problem, but it has yet to provide any evidence that's the case.
Despite a growing and increasingly engaged audience, Snap's ability to effectively monetize that audience is still under question. Greenfield originally expected Snap to grow its average revenue per user 28% year over year in the second quarter thanks to the self-serve platform and increasing the number of ads users see per minute in the app. Snap ended up only increasing revenue per user 8.8%.
As a result of the slower-than-expected growth, Greenfield slashed his 2020 revenue forecast for the "camera company" in half. That's a huge impact from just one question mark in Greenfield's financial model for the company. Snap's model is loaded with question marks.
Stick with the winners
Despite Snap's user engagement, investors could do better with proven winners like Facebook and Google. While they don't have the same upside as Snap, they each have clear competitive advantages and have proven an ability to monetize their growing audiences. They're also some of the most well-positioned companies to take advantage of the shift of time spent watching television to time spent on mobile.
Facebook and Google have combined to take nearly all of the growth in digital ad spend over the last few years. While companies like Snap have grown considerably in that time, others have seen a decline in ad revenue.
It's easy to see Snap becoming one of those companies with declining revenue in the future, as marketers still aren't completely sold on its ad products. It's a lot harder to see a huge turn in the fortunes of Facebook or Google, who have been successfully courting the bulk of advertisers' digital ad budgets for years.
Both Facebook stock and Alphabet stock are much easier to judge as investments than Snap stock. They've already reached scale with advertisers and have proven capable of building out new platforms for both users and advertisers (e.g., Instagram, YouTube). Both are in the strongest position to capitalize on the megatrend of ad budgets shifting to digital.
You don't have to swing at any pitches, but if you're going to swing, at least swing at the pitch you can identify. The good news is, you have a lot longer to identify a "pitch" than the half-second major-leaguers usually get.
Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Adam Levy has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Alphabet (A and C shares) and Facebook. The Motley Fool has a disclosure policy.