Is It Finally Time to Buy Snap Stock?

Shares of Snap (SNAP 24.69%) surged more than 20% after the Snapchat maker posted its fourth-quarter report on Feb. 5. Its revenue rose 36% annually to $390 million, beating expectations by nearly $13 million.

Snap's adjusted EBITDA loss narrowed from $159 million to $50 million. Its net loss shrank from $350 million to $192 million. On a non-GAAP basis, its net loss per share went from $0.13 to $0.04, which was better than estimates by $0.15.

Check out the latest Snap earnings call transcript.

Those numbers were encouraging, but do they indicate that it's safe to buy Snap's stock, which still trades at about half its IPO price?

Image source: Getty Images.

First, the good news...

Snap's daily active users (DAUs) stayed flat sequentially and dipped less than 1% annually to 186 million during the quarter. That broke a two quarter streak of sequential DAU declines, and indicates that Snapchat is no longer losing users to Facebook's (META -0.40%) Instagram.

Source: Snap quarterly reports.

Meanwhile, Snap's average revenue per user (ARPU) rose 31% sequentially and 37% annually. This indicates that its growth in ad revenues -- which suffered a slight dip in the first quarter as it shifted to automated ad buys -- remains robust.

Source: Snap quarterly reports.

Snap attributes that growth to higher views of video ads among younger users, its introduction of non-skippable 6-second video ads, the rising viewership of Publisher Stories and Original Shows, and its overseas push into Europe, the Middle East, and India. Snap grew its ARPU by 23% annually in North America, 57% in Europe, and a whopping 120% in its Rest of World region.

Snap also stated that over 70% of its users played with its AR Lenses daily and that it engaged advertisers with its e-commerce-oriented Product Catalogs and Collection Ads, which let advertisers showcase four different products in a single ad. It also said that the early test results for its new Android app looked "promising". Snapchat also remains the top social network for U.S. teens in most industry surveys.

Snap also carefully controlled its total costs and expenses, which fell 10% annually to $585 million. The combination of stabilizing DAU growth, rising ARPU, and narrowing losses indicate that Snap could potentially achieve non-GAAP profitability within a few quarters.

Now the bad news...

Snap's progress looks solid, but its revenue growth is still decelerating. Its 36% sales growth for the fourth quarter represents its slowest growth rate since its IPO, and it anticipates just 24%-34% annual sales growth in the first quarter.

Image source: Getty Images.

Meanwhile, Snap is still burning cash. Its negative free cash flow (FCF) of $149 million marked a year-over-year improvement of $49 million, but it remains a long way from turning positive.

Snap's stock-based compensation (SBC) expenses fell 33% annually to $122 million during the quarter, but they still accounted for 31% of its total revenue. Facebook, for comparison, spent just 6% of its revenue on SBC expenses last quarter.

Snap relies heavily on stock bonuses because its cash flow is negative. However, those high SBC expenses widen the gap between Snap's GAAP and non-GAAP losses since they're included in the former and excluded from the latter. For the full year, Snap posted a net loss of $0.97 per share on a GAAP basis, but just $0.47 per share on a non-GAAP basis. Unless Snap takes steps to curb its SBC expenses, it will keep burning cash and stay unprofitable on a GAAP basis.

Snap stopped bleeding DAUs during the quarter, but that doesn't mean that figure will start climbing again. Its user growth still trails that of other social networks -- Facebook, for example, grew its DAUs 9% annually to 1.52 billion last quarter, and Instagram Stories grew its DAUs from 400 million to 500 million between last June and this January. Snap is still squeezing more revenue out of its DAUs, but that strategy might be unsustainable over the long term.

Lastly, Snap's stock still isn't cheap at six times this year's sales. Facebook trades at nine times this year's sales, but it's also profitable and generating positive cash flows.

Snap has further to go

Snap's fourth-quarter results were decent, but I wouldn't call it a turnaround yet. Its post-earnings rally was likely sparked by a short-squeeze instead of enthusiasm from institutional investors, who only own about a third of its shares. I've repeatedly said that investors were too bearish on Snap, but I'd need to see more signs of improvement before buying this volatile stock as a long-term investment.