It's no secret the U.S. economy is going through a challenging period at the moment. High inflation has prompted the Federal Reserve to aggressively hike interest rates, often 75 basis points at a time, triple the more typical 25-basis-point move.
Inflation and interest rate hikes have put pressure on consumers' spending power, in turn forcing companies to cut their marketing budgets as they prepare to earn lesser returns on their investments. That's bad news for a company like Snap (SNAP -1.96%), the parent of social media platform Snapchat, because it's reliant on advertising dollars.
Snap stock fell a whopping 28% last Friday after the company reported its third-quarter financial results. The stock has now declined 90% since hitting its all-time high price of $83.11 in 2021. But there were some positive takeaways from the report. So has the pessimism gone too far and made Snap an attractive buy?
Snapchat's user base is still growing
And the growth is global. The third quarter saw an increase in daily active users (DAU) across every region the company tracks: North America, Europe, and the rest of the world. Overall, the global figure rose 19% year over year to 363 million, which could have positive implications for Snap's ability to recapture the attention of advertisers once the economy recovers.
Remarkably, Snap says it reaches 75% of people aged 13 to 34 years old across 20 different countries, and that makes the platform desirable for companies trying to engage with a young audience. Plus it's building new tools to help advertisers meet those users on their level, including augmented reality (AR) Lenses, which are already delivering major results.
A retailer recently used AR to enable Snapchatters to explore different types of outdoor furniture, and it resulted in a whopping 14-fold increase in the vendor's return on advertising spending. Similarly, a major clothing retailer drew 11 million impressions in the third quarter with its Lens, which allows consumers to try on clothes virtually using AR.
While such innovation is almost certainly part of advertising's future, Snap continues to struggle with new privacy rules instated by Apple last year that prevent Snap and other app creators from tracking their users across the internet. It has led to a drop in monetization with Snap's average revenue per user dipping 11% year over year to $3.11 in the third quarter.
But as time goes on, Snap's ad strategy might become less about targeting and more about engaging users who are proactively seeking AR-powered shopping experiences on the platform. It's because currently, Snap's monetization isn't driven by users interacting with their friends' content but comes instead from users watching content from creators and partners who have the power to influence consumer spending decisions.
Less revenue per user means slowing revenue growth
Despite Snap's average revenue per user declining, its increase in user base overall was enough to boost its third-quarter revenue a modest 6% year over year. But the company's quarterly results have been anything but linear recently.
Snap also refrained from offering revenue guidance for the current fourth quarter, so investors will have to make predictions with one hand tied behind their backs in what's arguably the most important period of the year. Holidays like Thanksgiving and Christmas tend to see an uptick in marketing spending as companies fight for consumers' dollars. And if there's one thing investors don't like, it's uncertainty, so the lack of guidance is one reason Snap stock was punished so heavily last week.
Slowing revenue growth also has other implications. A company like Snap thrives on constant innovation, but when there's less money coming in, it has to choose between spending less and sustaining large losses. Since the beginning of 2022, Snap has incurred a net loss of more than $1.1 billion.
Snap might still be a long-term buy
Despite the swathes of red ink for Snap this year, it's making moves now to cut costs and run a leaner business. In August, the company slashed 20% of its workforce, or around 1,300 staff, and it also shuttered some of its expensive, underperforming business ventures like the Pixy drone.
Plus Snap has more than $4.4 billion in cash, equivalents, and marketable securities on its balance sheet, so it has plenty of runway to continue investing in the business while operating at a loss. However, in this environment, investors might continue to punish Snap stock if the business doesn't begin to show consistent profitability on a generally accepted accounting principles (GAAP) basis.
But so long as the user base continues to expand and the company finds success in new ad experiences with tools like AR, there might be value in the stock over the long term. Since it's trading at a price-to-sales ratio of just 2.9 right now, close to its cheapest valuation since becoming a public company, this might be the time for investors to make a bet -- but perhaps a small one.