Snap (SNAP -0.07%) stock plunged 43% on Tuesday after the operator of the Snapchat messaging app surprised the market with a guidance cut.
In a filing with the Securities and Exchange Commission, the social media company said: "Since we issued guidance on April 21, 2022, the macroeconomic environment has deteriorated further and faster than anticipated. As a result, we believe it is likely that we will report revenue and adjusted EBITDA below the low end of our Q2 2022 guidance range."
A parade of tech companies has been offering bad news in recent weeks, including word of layoffs and hiring freezes. But Snap's warning may be the direst sign yet. The company only issued its second-quarter guidance a month ago, and we're barely past the halfway point of the period. It's rare to see guidance adjustments like this so early. Back in April, the company had called for second-quarter revenue growth in the range of 20% to 25%, and adjusted EBITDA in a range of zero to $50 million. Now, management says it expects top-line growth of less than 20% and an adjusted EBITDA loss.
Not surprisingly, the news appeared to drag down other digital advertising stocks. On Tuesday, Facebook-parent Meta Platforms (META 2.88%) was off 8%, Google-owner Alphabet (GOOG 5.34%) (GOOGL 5.32%) was down 5%, Pinterest (PINS 1.49%) was down 24%, and The Trade Desk (TTD 0.69%) was off nearly 19%.
In addition to the guidance cut, Bloomberg reported that Snap would slow down its hiring; it's now planning to add 500 employees by the end of the year.
Snap's update is one of the clearest signs yet that the economy is rapidly decelerating, and the chances of a recession are increasing. If you're an investor in any of these stocks, you may be getting worried, but there's one key principle to remember about the advertising industry.
Advertising is cyclical
Advertising is both closely correlated with economic growth and a leading economic indicator. Businesses spend more on advertising when they are confident it will lead to sales, and they pull back on ad spending when they don't have money to spend on it, or they don't think they will get good returns on the investment.
The early months of the pandemic offered a clear example of this: Ad spending on popular platforms like Facebook and Google quickly decelerated in the first half of 2020 before rebounding in the second half as the economy stabilized and government stimulus helped encourage consumer spending.
When an industry is cyclical, the primary determinant of its growth rate is the strength of the overall economy, which businesses have little direct control over. As the market's response to Snap's update shows, the ride down can be rough. It also shows why stocks like Alphabet are now cheaper than they've been in a long time.
What it means for investors
For Snap and its peers, this update suggests the next year or so is likely to be challenging. The Federal Reserve is expected to continue raising benchmark interest rates in order to bring down inflation and consumer demand, though that also increases the likelihood of a recession.
But the economy will eventually turn around, and when it does, the digital advertising industry is sure to bounce back. For long-term investors, then, the sell-off in these stocks looks like a buying opportunity.
Snap fell to just $12.79 per share this week -- its lowest price since the early days of the pandemic when its annual revenue was less than half what it is today. The stock could certainly continue to fall, especially if we get further evidence of a slowdown in the economy, but macroeconomic challenges shouldn't obscure Snap's core strengths as a fast-growing social media property popular with millennials and Gen Z. Meanwhile, the digital ad model has been shown by companies like Facebook and Google to be highly profitable at scale.
Snap should eventually get there with its own advertising-generated profits. It will just take longer than most investors thought.