Snap (SNAP 3.59%) shareholders went into the fourth-quarter earnings season knowing that the macro economy was weak, that the digital ad market had slowed, that Apple's user privacy changes had made tracking the effectiveness of ads more complicated, and that TikTok was a dangerous competitive threat.
Still, shareholders were disappointed on Jan. 31 when Snap reported flat year-over-year revenue results and a growing loss on the bottom line. Even worse, management is projecting a year-over-year revenue decline of 2% to 10% in the first quarter. Investors responded to the report by bidding the stock down by 8.5% the next day.
Despite all this, there are reasons to consider buying Snap stock. The company revealed several trends in that Q4 report that bode well for its long-term future. The worst of the declines in the digital ad market are over. Most of Snap's woes can be traced back to the fact that the growth in worldwide digital ad spending decelerated sharply -- from 29.5% in 2021 to 8.6% in 2022. However, according to a forecast from eMarketer, growth should begin to bounce back to 10.5% in 2023 and remain in the low double-digit percentages over the next several years.
If the digital ad market is at or near the bottom of its slide, should you buy this social media stock for its long-term growth potential?
Let's examine the pros and cons.
There are things to like about Snap
One big reason shareholders can remain positive is that the community continues to grow even in this shaky economy. For example, in Q4, it grew daily active users (DAUs) by 17% year over year to 375 million. Rising DAUs mean Snap is attracting more users, which is excellent. Marketers often prefer advertising on platforms that have rising DAUs.
Image source: Snap.
Even better, Snap's users are highly desirable to advertisers. For example, its community encompasses more than 75% of 13- to 34-year-olds in 20 countries -- a highly coveted age range. Additionally, the company developed a user base in more than 20 countries representing over 50% of global digital advertising spending.
Image source: Snap.
Last, Snap is more than a social media platform. It is a content platform, and, like all ad-supported content platforms, it is in the business of increasing the number of users that engage with its content, as the growth of viewership is a critical component of monetization. The more and longer Snapchat users view content on the platform, the more attractive the application becomes for advertisers. Although management didn't reveal any firm numbers in its Q4 letter to investors, it did say that more people are viewing its content -- both sequentially and year over year, and across many different content types. Suppose that is true -- once the digital ad market returns to growth, it augurs well for Snap's ability to grow its revenue.
A monetization problem
The slowing macro economy has decimated Snap's ad business. Unfortunately, the company has more problems than that.
Snap started as a brand advertising business. Brand advertising is a form of advertising that builds relationships with consumers over time by showing them repeated ads. But, more important, in 2019, Snap launched a direct-response advertising business named Dynamic ads that added juice to its revenue and became a hit product. Direct response is a form of advertising designed to elicit users to take action. That action can be anything from buying a product to downloading a game.
By 2020, its direct-response advertising started receiving strong adoption rates from retail, consumer packaged goods, restaurant, and gaming businesses. Marketers craved advertising formats that could provide measurable results during the pandemic. Results are easier to measure with direct-response advertising than with brand advertising.
Unfortunately for Snap, its direct-response business began underperforming when the global ad market slumped in 2022, which happened to follow the advent of various privacy initiatives that made ad engagement more complex to gauge. Snap needs to improve the performance of its ads to lure marketers back to the platform.
Over the long term, management believes refurbishing its Dynamic ad product will increase its advertisers' return on their marketing spending, improving the attractiveness of Snap's ads to companies. But what shareholders hate is that management says it will take some time for these improvements to help its monetization efforts and translate into improved revenue growth. Leadership is asking for a bit of faith. However, the bears are looking at the company's rapidly deteriorating revenue growth and are skeptical that those improvements will save the day.
SNAP Revenue (Quarterly YoY Growth) data by YCharts.
Whether Snap's ad improvements will work is uncertain today, and most investors hate uncertainty -- a prime reason that Snap stock has been underperforming even Meta Platforms lately.
Even if direct-response ad improvements substantially improve Snap's long-term ad monetization, the upgrades will likely fail to help the company reaccelerate revenue in the near term. Therefore, if you choose to invest in Snap now, you should prepare for a lackluster performance from the stock in 2023.
