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5 Red Flags for Snap's Future

By Leo Sun – Dec 11, 2021 at 1:12AM

Key Points

  • Snap clearly underestimated the impact of Apple’s iOS update.
  • It also overestimated its long-term growth potential.
  • Snap’s stock is still expensive, and its insiders are selling a lot of shares.

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Snap is still growing, but investors can't ignore the near-term risks.

Snap's (SNAP 1.21%) stock has tumbled nearly 30% over the past three months. Most of that decline occurred in late October after the social media company posted a messy third-quarter earnings report.

I bought all my shares of Snap more than two years ago for an average price of about $15, and I'm still fairly bullish on the stock. However, I still occasionally review the bearish case against Snap and see if those arguments counter my original thesis. Let's review the five red flags that the bears often highlight, and see if they make Snap a less compelling investment.

1. Underestimating Apple's big iOS update

One of the biggest challenges for online advertising companies this year was Apple's (AAPL 0.99%) iOS update, which enabled users to opt out of data tracking features and targeted ads.

A person takes a selfie.

Image source: Getty Images.

During a conference call in April, Snap's chief business officer Jeremi Gorman said the company was "supportive of Apple's approach" because it had "always believed that advertising should respect customers' privacy." Gorman also called privacy a "huge core value" for Snapchat.

Those confident statements, along with Snapchat's frequent jabs at Meta's (META 1.21%) privacy standards at Facebook in the past, suggested that Snap wouldn't be severely affected by Apple's iOS update.

During Snap's conference call in July, Gorman said it was still "too early to determine how long it will take until these changes are fully adopted, the scale of the potential interruptions to demand, or the ultimate impact on the longer-term growth of our business." Snap's vague comments represented a stark contrast to Meta's repeated warnings regarding an iOS-induced slowdown for its targeted advertising business throughout the year. 

But during the conference call in October, CEO Evan Spiegel finally admitted that Apple's update made it "more difficult for our advertising partners to measure and manage their ad campaigns for iOS." CFO Derek Andersen also said the iOS update would continue to generate headwinds for the "direct response" ads (about half of Snap's advertising revenue) in the fourth quarter.

As a result, Snap expects its revenue to only rise 28%-32% year over year in the fourth quarter, compared to analysts' expectations for 49% growth.

2. That rosy investor day target

Back in February, Snap held its first investor day. During the presentation, product chief Peter Sellis said Snapchat's self-serve ads put it "in a position to drive multiple years of 50 percent plus revenue growth."

That bold statement likely convinced many investors that Snapchat could easily weather Apple's iOS update, which was initially announced in 2020. Snap's management also didn't mention those forthcoming changes during its presentation, and the market started to value Snap as a company that could potentially grow its revenue 50% annually for the next few years.

That's why Snap's stock crashed 30% after it released its third-quarter earnings report: Its stock was priced for perfection, but it delivered imperfect results.

3. Its high valuations

Even after its post-earnings decline, Snap has a market cap of $86 billion. That's 22 times this year's sales forecast, and 15 times next year's sales.

Those price-to-sales ratios have cooled off significantly since Snap's stock hit an all-time high of $83.34 back in September, but the stock still can't be considered a bargain -- especially if its growth decelerates and causes it to reduce its rosy long-term forecast for more than 50% annual sales growth.

Analysts expect Snap's revenue to rise 60% this year and 39% next year. It might generate its first full-year adjusted profit this year, but the stock looks even pricier by that measure at over 100 times forward earnings.

4. Spotlight still can't outshine TikTok

Last year, Snap launched a short video platform called Spotlight and started to distribute $1 million each day to its top content creators. That loss-leading effort was a clear shot at ByteDance's TikTok, its top rival among teen users, but it still hasn't made much of an impact.

Snap gradually reduced its Spotlight payments this year, and many of its top creators promptly left the platform for TikTok, Meta's Instagram, and Alphabet's YouTube. Snap hasn't disclosed its exact growth rates for Spotlight yet, but a quick glance at its sparse, confusing, and mostly joyless content indicates it can't outshine TikTok yet.

5. All that insider selling

If Snap's insiders believed the company could actually grow its revenue at more than 50% each year, they would probably be buying a lot of shares.

But over the past three months, Snap's insiders sold nearly 26 times as many shares as they bought. Over the past 12 months, they dumped nearly 16 times as many shares as they purchased. That lack of insider confidence is a bright red flag. 

I'm holding my shares of Snap (for now)

I still admire Snap's resilience among younger users, its growth potential in the augmented reality market and the metaverse, and the gradual expansion of its platform into a "super app" for games, videos, and other content.

But these red flags also highlight problems that I can't ignore. Snap clearly underestimated its weaknesses while overestimating its own strengths, and its insiders don't seem to have any confidence in its ambitious long-term plans. Therefore, I'm not selling my shares of Snap yet -- but I won't buy any more shares until it addresses these glaring problems.

Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. Randi Zuckerberg, a former director of market development and spokeswoman for Facebook and sister to Meta Platforms CEO Mark Zuckerberg, is a member of The Motley Fool's board of directors. Leo Sun owns Apple and Snap Inc. The Motley Fool owns and recommends Alphabet (A shares), Alphabet (C shares), Apple, and Meta Platforms, Inc. The Motley Fool recommends the following options: long March 2023 $120 calls on Apple and short March 2023 $130 calls on Apple. The Motley Fool has a disclosure policy.

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