Snap (SNAP -2.33%) just delivered another blowout earnings report.
Shares of the Snapchat parent rose 7.5% on Friday as revenue jumped 66% to $770 million in its first quarter, and daily active users were up 22% to 280 million. In both categories that was the company's fastest quarterly growth in three years, and Snap posted its first quarter of positive free cash flow, coming in at $131 million.
After investors left the stock for dead shortly after its 2017 IPO, Snap has staged a remarkable comeback, investing in new ad products, rebuilding its Android app, and innovating with new features that have made the app a favorite among Gen Z and millennials.
Snap wowed the market at its Investor Day conference in February, forecasting annual revenue growth around 50% for the next few years before factoring in new products like Spotlight and Maps. The latest report shows the company is building momentum that will propel its growth over the long term. Let's take a look at two big reasons why.
Image source: Getty Images.
1. Innovate, innovate, innovate
As a percentage of its revenue, Snap spends significantly more than its social media peers like Facebook, Twitter, and Pinterest. Last year, Snap spent 44% of its revenue on R&D, and 51% the prior year. By comparison, in 2020 Facebook spent 21% of its revenue on R&D, Twitter's R&D spending was 23%, and Pinterest's came in at 36%.
The fruit of that R&D spending is evident with Snap as it rolled out several engagement-driving new products in recent years like Spotlight, Lens Studio, and Maps that have strengthened its connection with users. The chart below shows the company's track record of new products.
Image source: Snap.
Snapchat pioneered vertical video, and invented probably the most imitated product in social media -- Stories -- which is now featured on Facebook, Instagram, Twitter, and even LinkedIn. However, the company learned from that experience and its new products like Lens Studio, which allows users to design their own lens filters, are more defensible and have made Snapchat a unique platform.
Much of the company's R&D spending comes in the form of stock-based compensation so there isn't a direct cash impact on the business from that portion of it, but its commitment to R&D represents an investment in the long-term growth of the business. With revenue expected to grow by 50% or more, profits should scale up as well, as it leverages those research and development investments.
2. Augmented reality
Snap's biggest advantage over its social media peers and in the broader digital advertising industry is its focus on augmented reality through features like Lenses and Camera Kit. Not only do those distinguish the platform for its users, they also help give advertisers a unique way to connect with potential customers.
Management noted on the earnings call that the number of Snapchatters using AR lenses rose by 40% year over year in the first quarter, nearly double the rate of its overall user growth. The pandemic helped accelerate interest in AR among brands as the stay-at-home effects of the crisis forced them to find new ways to connect with customers, but those patterns are sticking now. According to a study from Deloitte that Snap shared, 94% of people are expecting to use AR for shopping at least as much in 2022 as they do in 2021.
AR products are also delivering strong return on investment for advertisers. A lens promoted by Dior, for example, generated 6.2 times return on ad spend, while a Valentine's Day shoppable lens from Zenni Optical produced a 7.9 times return on investment.
On the earnings call, CEO Evan Spiegel concisely summed up his view of AR, saying, "I think, as we think about the future of augmented reality, really the promise of augmented reality is that you can interact with computing in a way that's similar to how do you interact with the physical world around you." The applications for AR are enormous, including e-commerce, gaming, or product discovery, like scanning a bottle of wine to read reviews, one of the features Snapchat offers.
AR is still in its infancy, but it will only become more widely embraced, especially by the Snapchat generation, as the technology improves. Though AR may not yet be moving the needle for Snap, the company is the leader in the emerging technology and it has a large, engaged user base already adopting it.
Time to buy?
Snap shares are expensive, trading at more than 30 times trailing sales, and it's still not profitable on a generally accepted accounting principles (GAAP) basis. However, Snap is expensive for a reason. It's a high-quality, unique business with huge potential growth in front of it.
The company expects revenue to jump around 82% in the second quarter, lapping the worst of the pandemic a year ago, and the 50% growth target over the coming years shows the business has passed a tipping point with its execution and scale.
The growth stock is up nearly 300% since the beginning of 2020, but with its momentum and track record of innovation, the company looks like a good bet to continue to outperform the market.
