3 Great Reasons to Buy Snap Stock

Snap's (SNAP -1.64%) stock more than tripled in 2020 as the social media company impressed investors with its robust growth in revenue and users. Concerns about competition from Facebook's (META -4.40%) Instagram and ByteDance's TikTok also faded as the company's bottom line improved.

Investors might be thinking about taking some profits after that big rally, but I believe Snap remains a compelling buy, for three simple reasons.

Image source: Getty Images.

1. Rapid growth

Snap's revenue rose 45% to $1.72 billion in 2019, then grew another 38% year over year to $1.6 billion in the first nine months of 2020, even as the pandemic throttled ad purchases in the second quarter.

Snapchat's daily active users (DAUs) rose 18% year over year to 249 million in the third quarter. That marked an acceleration from the second quarter, as well as a continuation of its stable DAU growth over the past year:

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

Snap expects its DAUs to rise another 18% year over year to 257 million in the fourth quarter with 47%-50% revenue growth. If Snap hits the high end of that forecast, its full-year revenue would rise 42% to $2.4 billion.

Wall Street expects Snap's revenue to rise another 42% in fiscal 2021. Those year-over-year growth rates -- which are buoyed by Snapchat's popularity with Gen Z users and the ongoing expansion of its ecosystem with new videos, lenses, and games -- indicate it shouldn't worry too much about Instagram and TikTok.

2. Narrowing losses

Snap spooked investors with its massive losses when it went public nearly four years ago. However, the company gradually narrowed those losses -- and it now has a viable path toward non-GAAP profitability:

Note: 2020 figures are for the first nine months only. Source: Snap.

Snap's net loss widened year over year in the first nine months of the year, mainly due to its pandemic-induced slowdown in the second quarter. However, its GAAP loss narrowed significantly in the third quarter, and it posted a surprise profit by non-GAAP and adjusted EBITDA measures.

Snap attributed those gains to higher ad prices and tighter infrastructure expenses. Analysts expect it to post another non-GAAP profit in the fourth quarter, which would narrow its loss to just $0.09 per share for the full year.

For fiscal 2021, they expect Snap to post a non-GAAP profit of $0.23 per share, which would mark its first full-year profit. If Snap can gradually reduce the stock-based compensation expenses that consumed over a third of its revenue in the first nine months of 2020, it could eventually turn profitable by GAAP measures as well.

In other words, the bears who claimed Snap would run out of cash before turning profitable could be proven dead wrong later this year.

3. It's still cheaper than other growth stocks

At $50 a share, Snap trades at about 30 times this year's sales and 22 times next year's sales. That makes it a bit pricier than Pinterest (PINS -1.90%), another high-growth social network that generates over 40% sales growth and trades at 18 times next year's sales.

However, Snap and Pinterest are both cheaper than many other recent high-growth tech IPOs. The bears might argue that investors are overpaying for those newer stocks instead of underpaying for Snap, but Snap's trailing P/S ratio is currently lower than its P/S ratio following its IPO in early 2017 when the stock was still trading at much lower levels:

Source: YCharts

This trend indicates that Snap's stock hasn't gotten overheated yet, and its ongoing rally is still supported by its underlying growth.

The bottom line

Snap could remain a volatile stock throughout 2021, but these three key strengths -- along with the fierce loyalty of its Millennial and Gen Z users -- could propel the stock to even higher levels over the next few years.