Uber (UBER -0.38%) recently reported second-quarter results, with revenue of $9.2 billion missing Wall Street analyst expectations. But the management team did offer strong guidance, and Uber posted its first-ever operating profit. Nonetheless, shares have trended lower since the announcement, even though they're up 77% this year (as of Aug. 11).
The business might be turning the corner from a financial perspective, but it's a good idea not to rush and add Uber to your portfolio just yet. There are some key considerations to keep in mind.
Let's look at one reason investors would want to buy Uber stock right now, and one important reason to hold off on purchasing shares in this transportation-as-a-service business.
1 reason to buy: Powerful network effects
By connecting riders and drivers, Uber operates a two-sided platform with its Mobility service. This means that the business benefits from network effects. The more active drivers that Uber has, the more valuable the service is to riders because there are more cars to get matched with quickly. And if there are a lot of riders looking to go somewhere, it's advantageous to a driver because they have the potential to make more money.
In the Delivery segment, Uber runs a three-sided platform, throwing restaurants (and other stores) into the mix with both consumers and drivers. Consumers benefit from more food choices being available. Restaurants benefit by reaching a wider customer base. And drivers can make more money, thanks to more orders.
Network effects are what make up Uber's economic moat, or its ability to defend against rivals and discourage new entrants from getting into the market. That's because as Uber gets larger, its service gets much better for all stakeholders involved. Imagine how useless it would be if there was one rider and one driver on the platform in a major city. As the user base grows, it's easier to find a match. This leads to tremendous growth. Moreover, it should become cheaper and easier to attract new customers because the service is already so valuable.
At a certain level of scale, network effects also lead to positive profitability. In the latest quarter, there were nearly 2.3 billion trips completed on Uber. Gross booking value for Mobility and Delivery totaled $16.7 billion and $15.6 billion, respectively. Consequently, Uber was able to report an operating profit of $326 million and free cash flow of $1.1 billion. Perhaps this is a sign of consistent financial strength going forward.
1 reason to hold off: Lack of switching costs
Switching costs can also be a part of a company's economic moat. They come about when customers are locked in through a contract, or when they simply don't want to go through the hassle of changing their provider. A perfect example would be moving your main banking relationship to another company.
However, Uber doesn't have switching costs. Drivers are free to work for Uber, Lyft, DoorDash, or any other service there might be, depending on where they might get the most business or earn the most money at any given time. Riders can go where the fares are the cheapest or where the wait is the shortest. Riders can also use other means of transportation to get somewhere, like walking, biking, or taking a bus or a train. And there are myriad options from which to get food or groceries.
This situation hurts Uber because it will always have to offer expensive discounts and promotions to customers and incentives to drivers to encourage greater use and keep them on the platform. Sales and marketing expenses of $1.2 billion in the latest quarter were identical to the year-ago period. But Uber just posted its slowest revenue growth in the last nine quarters. Maybe it will need to ramp up spending to boost its top line.
Additionally, it's noteworthy that all stakeholders will generally never be fully satisfied. Riders complain that fares are expensive during hours of high demand. Drivers have been pushing to get benefits and higher pay. And restaurants, despite the ability to increase sales, complain that Uber's fee is too much.
From an investment perspective, it's best to weigh these considerations before making a decision with the stock.
