Social media specialist Snap (SNAP -4.04%) is facing serious headwinds. Like many other businesses that rely on advertising to make a buck, the company has seen its financial results suffer due to a decrease in ad spending amid an economic slowdown. Snap's latest quarterly update was poorly received by investors, with many heading for the exits and selling off the company's stock.
As a result, Snap's share price is currently hovering near its 52-week low, but is the company worth investing in even at current levels? Let's consider one argument on either side of that debate.
Green flag: Snap's growing ecosystem
Snap's user growth and engagement are important aspects of its business. The more people that use its platform, the more attractive it is for companies to advertise on it, all else being equal. Snap is already one of the leading social media companies, but it continues to increase its user base.
In the first quarter, Snapchat's daily active users (DAUs) improved 15% year over year to 383 million. Snap's engagement also continues to move in the right direction. Here's one way to see this. In the period, Snap's users increased the time spent watching Spotlight by 170% year over year. Spotlight is a collection of short-form videos created by Snapchat's users.
Snap is arguably building a network effect, a dynamic that refers to the value of a service increasing with use. The more DAUs on the company's platform, the more it becomes a target for potential advertisers. Snap also uses the data on user habits and trends it collects to guide its recommendations for specific users on Snapchat.
And the more people on the social media app, the more data the company can collect to help keep its users glued to their screens. This potent competitive advantage will only strengthen as Snap continues to increase its user base.
Red flag: Things could get worse
Despite an improvement in DAUs and engagement, Snap's revenue in Q1 dropped by 7% year over year to $988.7 million. Furthermore, the company remains unprofitable, although it improved on that front in its most recent reporting period. In the quarter, Snap's net loss of $328.7 million was 9% better than the loss it reported in the comparable period of the previous fiscal year.
Snap blamed its declining revenue on changes it made to its ad platform. And while the company did not issue guidance for the second quarter, it revealed an internal forecast in its letter to shareholders that signals that things might not improve markedly anytime soon. Snap's internal revenue forecast for Q2 is $1.04 billion, which would represent a 6% year-over-year decline.
But there is one crucial reason beyond management estimates that the worst might not be over for the social media specialist. The U.S. Federal Reserve recently forecasted a recession for later this year. With news of a coming recession, we are unlikely to see an increase in ad spending at least until the end of the year. Snap's revenue could remain under pressure for longer, further sinking its already struggling stock.
Here's another thing that could limit the company's revenue growth: The threat from other social media platforms. Snap has to contend with such social media apps as TikTok, a now infamous platform for short-form videos. TikTok ended 2022 with 1.7 billion users, according to Statista. And that number will continue to grow rapidly.
There are other players in this field. Meta Platforms released Reels on its Facebook and Instagram platforms to dip its toes in the short-form video area, and it has become a fast-growing feature for the company. That's not surprising: Meta can target the roughly 2.04 billion DAUs across Facebook alone to grow Reels.
This stiff competition is something with which Snap will have to deal moving forward, and it could disrupt the company's prospects.
Is Snap stock a buy?
Snap's shares are currently exchanging hands for about $8 apiece. At these levels, the company is worth investing in, at least in my view. Although it is unquestionably facing problems, many of these issues should subside on the other side of the economic headwinds and potential recession we might soon face.
Once the dust settles and ad spending bounces back, Snap will still be a prime target for advertisers, especially those targeting younger generations with which Snapchat is so popular.
Also, while competition is fierce in the social media industry, these platforms are not necessarily mutually exclusive. When it comes to short-form videos, many content creators operate across multiple websites and apps. Snap has continued to grow its DAUs relatively rapidly despite this issue.
Furthermore, the company has been diversifying its revenue. It is a leader in augmented reality and has been ramping up its paying Snapchat+ service.
It could take a while before Snap reaches the all-time high of more than $80 per share it hit in late 2021, but the company has the tools to make it happen.
