Social media stocks have many hallmarks of a strong investment. First, the business model is highly scalable with the ability to easily support an incremental user. Second, social media operates under a third-party payment system where the user does not pay for the service, lessening the friction for users to join. Finally, social media continues to have a runway for growth, bolstered by network effects alongside geographical and demographic tailwinds.

Unfortunately, the reality hasn't matched expectations for most social media companies. Except for Facebook, social media investments have trailed the greater market. As of this writing, shares of Snap Inc. (NYSE:SNAP) are still below their 2017 IPO price. Twitter (NYSE:TWTR) recently eclipsed its $26 IPO price, but took years to do so. Here's what you should consider when deciding between Twitter and Snap.

Teens using their smartphones to post on social media.

Image Source: Getty Images

The case for Twitter

If social media networks were defined by their relevance to the body politic, then Twitter would be the largest company in the industry. Twitter often drives news cycles, and President Donald Trump is often referred to as the "Tweeter-in-Chief" due to his penchant to announce policy changes and communicate his priorities on the service.

The fundamentals case also supports Twitter over Snap. For years, the company had been unprofitable on a generally accepted accounting principles (GAAP) basis, mostly due to high and disproportionate stock-based compensation expenses. Twitter's recently reported fourth-quarter earnings were a hallmark of sorts, as it was the first time the company reported GAAP profitability.

The case for Snap Inc.

At this point, there's not a strong fundamentals case for Snap and its Snapchat social media network. Currently the company has a higher market capitalization than Twitter, although the company has worse financials. Shares of the company exploded after reporting better-than-expected fourth-quarter earnings. Lost in the ebullience was the inconvenient fact the company is still unprofitable on an adjusted EBITDA basis with free cash flow and gross margins decreasing from last year's quarter.

However, the case for Snap rests with both its growth trajectory and its target demographic. As per the former, in the fourth quarter Snap grew daily active users 18% on a year-over-year basis and increased its top line 72%. Snap increased full-year revenue 104% from the prior year, and analysts project the company will grow revenue 60% this year.

The second reason is demographics. As of 2017, approximately three-quarters of Snapchat users were younger than 34, a highly coveted demographic for advertisers. Users under the age of 25 spent 40 minutes a day on the service, more than Facebook's Instagram.

Final verdict

Investors need to consider the increasing threats to the social media business model. Facebook's data breach has called into question the prudence of collecting and selling data on your consumers, which could be a tail risk for the entire industry in the event of regulation or a shift in user sentiment.

However, if you're comfortable bearing this risk and are looking to decide between these two smaller social media companies, Twitter is currently the less-risky investment, and Snap is a bet on continued growth from the company and for the industry overall.

 

 

Jamal Carnette, CFA has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Facebook and Twitter. The Motley Fool has a disclosure policy.