Snap's (NYSE:SNAP) stock recently skyrocketed after its third-quarter numbers shattered expectations. Its revenue surged 52% year-over-year to $679 million, marking its strongest growth in over two years and beating estimates by $127 million.

Snap's net loss narrowed from $227 million to $200 million, and it generated an adjusted EBITDA of $56 million -- compared to a loss of $42 million a year ago. That trickled down to a non-GAAP profit of $0.01 per share, which topped expectations by six cents.

Snap's headline numbers were impressive, but is the stock worth buying at its all-time highs? Let's dig deeper to find out.

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Image source: Getty Images.

Accelerating DAU growth

Snapchat's daily active users (DAUs) grew 18% year-over-year to 249 million during the third quarter, which marked an acceleration from the previous quarter.

DAU Growth

Q3 2019

Q4 2019

Q1 2020

Q2 2020

Q3 2020

QOQ

3%

4%

5%

4%

5%

YOY

13%

17%

20%

17%

18%

Source: Snap Q3 2020 report. QOQ = Quarter over quarter. YOY = Year over year.

Snapchat's DAUs in North America stayed flat sequentially and remained slow in Europe, but its growth in its Rest of World region accelerated.

Region

DAUs (Q3 2020)

QOQ Growth

YOY Growth

North America

90 million

0%

7%

Europe

72 million

1%

10%

Rest of World

87 million

13%

43%

Source: Snap Q3 2020 report. QOQ = Quarter over quarter. YOY = Year over year.

Snap didn't break down its Rest of World region by individual country, but it highlighted India, which banned ByteDance's TikTok in late June, as a key growth market during its conference call.

Snap expects its total DAUs to rise another 18% year-over-year to 257 million in the fourth quarter, which indicates it isn't losing ground to TikTok, Facebook's (NASDAQ:FB) Instagram, or other Gen Z challengers.

Accelerating ARPU growth

Snap's average revenue per user (ARPU) rose 28% year-over-year to $2.73, accelerating from its flat growth during the pandemic-stricken second quarter. Its accelerating ARPU growth in North America and Europe offset a slight decline in the Rest of World region.

Region

ARPU (Q3 2020)

QOQ Growth

YOY Growth

North America

$5.49

61%

46%

Europe

$1.43

30%

36%

Rest of World

$0.95

7%

(6%)

Total

$2.73

43%

28%

Source: Snap Q3 2020 report. QOQ = Quarter over quarter. YOY = Year over year.

Those numbers tell us two things. First, Snap's ARPU growth rates in North America and Europe -- which are buoyed by its ever-expanding ecosystem of filters, lenses, videos, games, and other content -- are easily offsetting its slower growth in DAUs. It also noted that the easing of COVID-19 restrictions in North America and Europe generated a "modest" tailwind for engagement rates throughout the quarter.

Second, Snap attributed its ARPU decline in the Rest of World region to its DAU growth outpacing its ad sales. But that gap could close in the future as advertisers pay more attention to Snapchat's DAU growth rates.

A sticky advertising ecosystem with expanding margins

Snap's eCPM (effective cost per thousand impressions, or the average revenue Snap generates from its ads) rose 20% year-over-year during the quarter, marking its first quarter of eCPM growth as a public company.

This indicates Snap's pricing power in the advertising market is improving. But during the conference call, CFO Derek Andersen declared Snap's eCPM remained "well below market rates" -- which indicates it still has room to raise prices as it expands its ecosystem with higher eCPM ad products like video commercials.

Snap's gross margin expanded seven percentage points year-over-year to 58% during the quarter, thanks to its higher ad revenue and tighter infrastructure spending. Its infrastructure costs per DAU stayed flat from a year earlier at $0.70, so the aggressive expansion of its ecosystem isn't boosting its hosting expenses.

Its operating expenses rose 24% year-over-year to $338 million as it expanded its headcount and ramped up its investments. But that spending still trailed its revenue growth, enabled it to post a surprise adjusted EBITDA profit, and improved its free cash flow from negative $85 million a year ago to negative $70 million.

Andersen also reiterated Snapchat's long-term goals of generating a GAAP profit and a positive free cash flow. Andersen didn't provide exact guidance for the fourth quarter, but declared 47%-50% year-over-year revenue growth will be "attainable" if the "current favorable operating conditions persist" into the holidays.

Is it too late to buy Snap?

If Snap's revenue rises 50% in the fourth quarter, its full-year revenue would grow 42% to $2.4 billion. Based on its current market cap of $53.6 billion, the stock would trade at 22 times this year's sales. Facebook, which is firmly profitable, trades at 10 times this year's sales.

Snap's valuation might seem frothy, but it traded at over 30 times sales when it went public. Its price-to-sales ratio gradually cooled off as its stock rose, so it's getting cheaper as it grows into its valuation. Based on those facts, I believe Snap remains a compelling investment for investors who can stomach the near-term volatility.