Up 200% in the Past Year, Is Snap Stock a Smart Buy?

Snap (SNAP 22.06%) has benefited from strong user engagement throughout the pandemic, much to the delight of shareholders. The stock price has skyrocketed 200% over the past year, crushing the performance of the broader S&P 500. But after that impressive run, Snap now has a market cap of $118 billion, and investors may be wondering: Is it too late to buy this social media stock?

To answer that question, let's take a closer look at Snap's business and its prospects for future growth. Here's what you should know.

Strong user engagement

Snap brands itself as a camera company. Its primary product is Snapchat, a mobile app that connects people with friends, family, brands, and local businesses.

Image source: Getty Images.

More specifically, Snapchat allows users to interact through text, images, and video, and it provides a range of tools (e.g. augmented reality lenses) that help people create personalized messages. The mobile app also includes a live map that allows users to engage with their surroundings, such as ordering food for takeout or making reservations at a local restaurant.

In the past, I've overlooked Snap as an investment opportunity, but its user metrics are difficult to ignore. Snapchat now has 293 million daily active users (DAUs), including 75% of the millennial and Gen Z populations in the U.S. And on average, DAUs open the app 30 times each day, and they spend 30 minutes engaged with Snapchat content on a daily basis.

This makes it possible for Snap to monetize its business through digital ads. Specifically, it provides AI-powered tools that help marketers launch, measure, and optimize targeted campaigns on its platform. These digital ads take the form of short videos or images; but brands can also create sponsored filters and lenses, such as augmented reality overlays featuring a corporate logo.

Financially, Snap has delivered a strong top-line performance in recent years, though the company is still unprofitable on a generally accepted accounting principles (GAAP) basis.

Source: YCharts. TTM = trailing 12 months. CAGR = compound annual growth rate.

Despite this rapid sales growth, Snap is still burning cash. Over the last 12 months, it generated a negative free cash flow of $128 million. And while that number marks an improvement over the prior year, investors should still monitor this metric.

Snap currently has $3.4 billion in cash and marketable securities on its balance sheet, compared to $2.6 billion in debt. But if the company is unable to generate free cash flow in the near future, it may be forced to raise capital through debt or equity (i.e. selling new shares), neither of which would be good news for shareholders.

Big market opportunity

Snap still has plenty of room to grow its business. Digital ad spend in the U.S. will reach $279 billion by 2024, according to eMarketer. And Snapchat reaches nearly half of U.S. smartphone users, though it currently captures less than 2% of digital ad spend in this market. To change that, management is executing on a strong growth strategy.

For instance, Snapchat's Scan feature allows users to shop based on saved photos or screenshots, making the platform an e-commerce discovery tool. Snap has also partnered with companies like Walt Disney and Bumble to integrate its camera and lenses with other applications. Finally, the company recently announced its latest pair of Spectacles for creators, Snap's first hardware device that features a built-in 3D augmented reality display. In general, these moves should drive user engagement, making Snapchat a more valuable platform for advertisers.

So, is it too late to buy this stock? I don't think so. If Snap can maintain its momentum with younger generations and make its app more commerce-friendly, advertisers should continue to spend more money on its platform. And with global digital ad spend set to hit $645 billion in 2024, the company certainly has a massive market opportunity.

That being said, I'm still sitting on the sidelines. I'd like to see positive free cash flow for a few consecutive quarters before I add this growth stock to my own portfolio.