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Will Snap’s Improving Outlook Continue to Help Its Stock?

By Will Healy - Updated Jan 24, 2020 at 10:09AM

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Most of Snapchat’s successes will likely not accrue to the shares.

Shares of Snap (SNAP -1.20%) benefited from a massive comeback in 2019 after once flirting with penny-stock status. Investors came back to Snap, and it now trades in the $19 range as of the time of this writing. This occurred as ad sales drove revenue higher, and the company made competitive gains against archrival Instagram.

But the growth has made Snap stock relatively expensive. Moreover, Snapchat has not enjoyed the broad appeal of its peers; although it can probably maintain a significant audience, its benefits may not continue to accrue to Snap investors.

Winning at Facebook's game

Snap stock has more than tripled since being arguably left for dead one year ago. At that low point, it had fallen below $6 per share as Facebook (META 1.29%) continued to co-opt its apps, and Instagram made a direct play for its teen and young adult base.

Girl reacting to something on her smartphone.

Image source: Getty Images.

Conditions improved when Snap finally began to steal features from Facebook, namely the ad platform. Incorporating ads not only created a new source of revenue, but it also breathed new life into Snap stock. With this success, analysts expect Snapchat to grow its user base despite competition from Instagram.

In Snap's most recently reported quarter, revenue increased by 50% while average revenue per user rose by 33% on a year-over-year basis. Analysts now believe the company can begin turning a profit in fiscal 2022.

But Snap needs more

Unfortunately, these successes offer only so much help to Snap stock. Despite improvements, Snapchat has failed to develop a serious following outside of its core teen and young adult audience. As a result, Pinterest (PINS -0.91%) has now surpassed Snapchat as the third most popular social network. 

This presents two key challenges for Snapchat. First, Pinterest appeals to a broader range of age groups, giving it a larger potential audience. Second, these different age groups hold more spending power than teens, presumably making it a more lucrative advertising draw.

As mentioned before, analysts do not expect a profit until 2022. This means the company may have to raise funds. Thanks to a much higher stock price, management could easily choose to dilute Snap stock. The company's price-to-sales ratio of more than 17.3 could make it particularly vulnerable to a drop if the company issues more shares.

Obstacles to future growth

Compared with other social media companies, Snap faces significant competitive disadvantages. Yes, Snapchat has gained ground on Instagram. Still, Instagram's parent company Facebook holds $52.27 billion in cash. In contrast, Snap holds only $2.26 billion in cash, and it will have to use much of that to cover losses for the foreseeable future. Conversely, Facebook could invest its cash on Instagram. If Instagram regains some of its lost ground, you have to wonder if and how Snap will fight back.  

Snap also compares poorly to other social media stocks. Twitter (TWTR -1.04%) earns a profit, while Pinterest's P/S ratio of about 12.2 comes in lower than that of Snap. Though Snapchat could easily remain popular among teens, keeping Snap stock fashionable with investors may become a tougher challenge.

Trading Snap stock

Investors should likely avoid Snap since Snapchat's growth may offer fewer additional benefits longer term. Yes, Snap more than tripled in the last year. Given the continued increase in the market, the stock may continue to rise for now. The company has impressed Wall Street with its successes in selling ads and by making competitive gains against the much better funded Instagram.

However, Pinterest recently overtook Snapchat in the number of users. Considering Pinterest's more universal appeal, Snapchat may never regain this lead. And with profits not expected until 2022, Snap will not only have to find ways to maintain its growth, but it will also have to contend with continuing losses. Due to the massive growth in Snap stock over the years, current shareholders may have to bear the cost if the company further dilutes the stock.

Given these factors, the only thing harder than maintaining Snapchat's growth may become maintaining the appeal of Snap stock. In a world full of high-flying tech stocks, Snap still has a lot to prove. 

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Stocks Mentioned

Snap Inc. Stock Quote
Snap Inc.
SNAP
$13.56 (-1.20%) $0.17
Meta Platforms, Inc. Stock Quote
Meta Platforms, Inc.
META
$162.76 (1.29%) $2.08
Twitter, Inc. Stock Quote
Twitter, Inc.
TWTR
$38.38 (-1.04%) $0.41
Pinterest Stock Quote
Pinterest
PINS
$19.52 (-0.91%) $0.18

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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