Where Will Snap Be in 5 Years?

When Snap (SNAP -4.04%) went public in early 2017, many critics claimed it would struggle to justify its high valuation, narrow its losses, and fend off Facebook's (META -4.13%) Instagram.

For a long time, the critics seemed right. Snapchat's daily active user (DAU) growth stalled out in 2018 as Instagram cloned its features. It continued burning cash and its price-to-sales ratio remained high.

Snap's stock slid below its IPO price of $17 in late 2017 and plunged to about $5 in 2018. It bounced back above its IPO price in early 2020, but the COVID-19 crash last March sent it back below $10.

Image source: Getty Images.

Yet that crash was actually a great buying opportunity, since Snap now trades at about $60. Let's see how Snap staged its incredible comeback and where its stock could be headed over the next five years.

How Snap made a comeback

If we track Snap's DAU growth over the past four years, we can see why investors turned bearish in 2018 before becoming bullish again.

Source: Snap. YOY = Year-over-year.

Snap's DAUs rose 22% year over year to 280 million in the first quarter of 2021, and it expects that figure to increase another 22% year over year to 290 million in the second quarter.

Snap's average revenue per user (ARPU) also continued to climb as its average ad prices rose. That growth can be attributed to its popularity with teen users, the expansion of its Discover tab with more video content, and its growing library of augmented reality lenses and in-app games.

Those features differentiated Snapchat from Instagram and locked in its users. That's why its revenue continued to grow over the past four years.

Source: Snap. YOY = Year-over-year.

Snap's revenue increased 66% year over year to $770 million in the first quarter of 2021, and it anticipates 81% to 85% revenue growth in the second quarter. That acceleration indicates Snapchat remains a top advertising platform for companies that want to target Gen Z consumers.

What the next five years could look like

Snap expects its revenue to grow more than 50% annually over the next few years. It expects that growth to be driven by the expansion of its self-serve advertising platform, a growing mix of higher-value ads like Commercials, and new AR-based ads in its lenses and games.

It could also evolve into a "social shopping" platform. It already offers shoppable ads and lets its users shop for products on Amazon (AMZN -2.56%) by taking photos. It recently acquired two start-ups, Fit Analytics and Craze, to accelerate that expansion. Snap's Spectacles smart glasses, which it still produces in small batches, could also eventually tie into those AR shopping features.

Image source: Getty Images.

Snap is also transforming Snapchat into a walled garden for games and "Minis", or mini programs which operate within the app. That strategy could make Snapchat more similar to Tencent's (TCEHY 0.10%) WeChat, China's top messaging and Mini Programs platform.

Tencent is already one of Snap's top shareholders, so it wouldn't be surprising to see Snapchat become an all-in-one "super app" like WeChat. Tencent is also the world's top video game publisher, so we might see some of its games appear on Snap Games in the future.

Snap has been testing out an in-app currency, called Snap Tokens, to monetize its games. Snap says it might eventually expand those Tokens beyond games to other in-app features. One potential use would be to tip creators on Spotlight, its TikTok-like feature for short viral videos.

The expansion of Spotlight could drive more users to Snap Map, which highlights public videos on a digital map. That platform could widen Snap's moat against TikTok's 700 million monthly active users.

Snap remains unprofitable, but its free cash flow turned positive for the first time ever last quarter as it reduced its infrastructure costs per DAU while boosting its ARPU with higher ad prices. If those positive trends continue, Snap could finally turn profitable on a GAAP basis within the next five years.

Snap's plans seem promising, but it still faces unpredictable headwinds. Recent data privacy changes on iOS and Android could affect its ad revenues, its debt levels are still rising, and TikTok's quiet expansion into a social media platform could threaten both Snapchat and Instagram.

Faster growth ahead

I won't guess exactly how much Snap will be worth in five years, but its smart expansion strategies and improved financial discipline indicate it still has room to run. The stock might seem a bit pricey at 23 times this year's sales, but its accelerating growth and clear plans for the future easily justify that premium valuation.