Throughout 2022, investors have grappled with a drastic change in the U.S. economic environment. Pandemic-era stimulus has mostly dried up, and the Federal Reserve has embarked on an aggressive campaign to fight inflation, which recently hit a 40-year high. The record-low interest rates of 2020 and 2021 are rapidly disappearing in the rear-view mirror.
There are some early signs that these pressures are easing, but according to Snap's (SNAP 2.89%) second-quarter earnings report, there's been a noteworthy decline in advertising demand. This points to a falling level of confidence among businesses in the strength of the consumer. Here are two key takeaways from the social media company's report, which it released on July 21.
1. Snapchat's user base grew, but revenue per user fell
Companies that rely on advertising for revenue are among the most sensitive to changes in the economy. When slowdowns occur, businesses tend to cut their marketing budgets because they feel the returns on that spending will be poorer due to consumers tightening their belts.
Snap is experiencing weakness from advertisers across the board. Management says the falloff began when Apple enhanced user privacy for iOS devices in 2021, which reduced social media platforms' ability to track users' online behavior. That made it harder to narrowly target ads to specific users, which led to reduced demand for those ads. The weakness was further exacerbated by more recent challenges like high inflation and rising interest rates, which are hitting the bottom lines of many corporations.
Therefore, although Snap's daily active users jumped by 18% year over year in the second quarter, its average revenue per user fell by 4% from the prior-year period.
Snap can't control the economic environment, but it's working on a series of projects to increase its average revenue per user. These include new tools to compensate for Apple's privacy changes, a greater focus on augmented reality advertising, which generates higher conversions for businesses, and even a subscription service that allows users to access exclusive Snapchat features for $3.99 per month.
2. Snap's revenue growth has slowed, sending losses soaring
The decrease in Snap's average revenue per user has led to companywide financial weakness. Its year-over-year revenue growth rate, which was 116% in Q2 2021, sank to 13% in Q2 2022.
Over the last four quarters, the company revenue growth has slackened in a meaningful way, which could indicate the trend of smaller increases is entrenched.
The problem is, if Snap wants to continue to build on its platform and deliver features to improve its average revenue per user, it will have to invest a significant amount of money. One of its largest costs in Q2, for example, was $318 million in stock-based compensation to help retain its workforce.
But if revenue growth continues to flatten, the company will find itself with a rapidly increasing amount of money flowing out. The left-hand side of the below chart shows how Snap's net losses improved when it was rapidly growing its revenue last year, and how they significantly steepened in 2022 as revenue growth decelerated.
Focus on the long term
Investors sent Snap stock 39% lower on the trading day after it reported its Q2 results. The stock is now down 78% in 2022 alone.
Historically, the U.S. economy has always bounced back in the long run. Assuming it will again, Snap's investments in improving the advertising experience for businesses will likely pay off when that recovery arrives. Not to mention, the company is making strides in its own vision for the metaverse.
In the short term, Snap shareholders might have to endure more pain until there's a clear path toward improved financial results. This might not be imminent since the company didn't issue any guidance for Q3. But Snap's user base continues to grow, so over the long run, it should remain a platform of choice for advertisers, particularly those trying to reach younger audiences.
