Where Will Snap Stock Be in 1 Year?

Snap (SNAP 27.63%) posted its third-quarter earnings report on Oct. 24. The social media company's revenue rose 5% year over year to $1.19 billion and exceeded analysts' expectations by $80 million. Its adjusted earnings tumbled 75% to $0.02 per share but still beat the consensus forecast by $0.07 per share.

Snap cleared Wall Street's low bar, but its stock still slumped after the report and remains nearly 50% below its IPO price.

Should investors buy this beaten-down stock and bet on a recovery over the next 12 months?

Image source: Getty Images.

What happened to Snap over the past year?

Snap faced three major challenges over the past year.

First, macro headwinds curbed the growth of the broader advertising market. Second, intense competition from ByteDance's TikTok and Meta Platforms' (NASDAQ: META) Reels chipped away at Snapchat's core audience of younger users. Finally, Apple's (NASDAQ: AAPL) privacy changes on iOS made it more difficult for Snap to tap user data to craft targeted ads.

Those headwinds caused Snap's revenue to decline year over year for two consecutive quarters before returning to growth in Q3 2023. Its average revenue per user (ARPU) also shrank as its growth in daily active users (DAUs) cooled off.

Data source: Snap. YOY = year-over-year.

A growing dependence on lower-revenue users

Snapchat ended its third quarter with 406 million DAUs. But only 101 million of those DAUs were in North America, which generated an ARPU of $7.82.

Another 95 million DAUs were in Europe with a lower ARPU of $2.11, while the remaining 211 million DAUs were scattered across the rest of the world, with an even lower ARPU of $0.96.

That massive gap between its North American and overseas ARPU is worrisome because its DAU growth in North America has nearly stalled. Its North American DAUs increased a mere 1% year over year during the third quarter, compared to its 7% uptick in European DAUs and 21% growth in rest-of-the-world DAUs.

In other words, Snap's mounting dependence on those overseas users for DAU growth is consistently reducing its total ARPU. To offset that pressure, the company needs to increase its North American ARPU -- which finally rose sequentially again in Q3 after two quarters of sequential declines -- and aggressively monetize its overseas users.

Its ecosystem is expanding, but margins are a mess

Snap plans to accelerate that monetization by expanding its direct response ads, rolling out new ad ranking and optimization features to counter Apple's platform changes.

The company also is promoting new products like First Story (which gives an advertiser access to a Snapchatter's first viewed story of the day) and Total Takeover (which allows an advertiser to reserve a Snapchatter's first commercial, Lens, or Snap Ad of the day).

Snap also plans to keep expanding its subscription-based Snapchat+ platform, which grew its revenue 250% year over year in third quarter as it reached 5 million paid subscribers, as well as increase the stickiness of its ecosystem with its My AI chatbot.

For the fourth quarter, Snap expects its DAUs to grow 9% to 10% year over year to 410 to 412 million as its revenue rises 2% to 6%.

However, it sees its adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) declining 55% to 72% year over year, which would equal a midpoint adjusted EBITDA margin of 6%. It will also likely stay deeply unprofitable on a generally accepted accounting principles (GAAP) basis.

That mix of sluggish ad growth and higher investments compressed Snap's margins over the past year, and that pressure should persist for the foreseeable future.

Data source: Snap.

Red on the balance sheet makes it a risky buy

Snap racked up a GAAP net loss of $1.1 billion in the first nine months of 2023 as it generated $3.2 billion in revenue. It won't run out of cash because it was sitting on $3.6 billion in cash, cash equivalents, and marketable securities at the end of the third quarter, but the company still had a high debt-to-equity ratio of 2.1.

That red ink and high leverage will likely prevent the bulls from rushing back as long as interest rates stay elevated. Snap also launched a new $500 million buyback plan to offset the dilution from its stock-based compensation, but that seems like a waste of cash when it should be prioritizing new investments across its advertising ecosystem.

Where will Snap's stock be in a year?

Snap's stock might seem cheap at about 3 times this year's sales, but I believe it will underperform the market over the next 12 months. Its advertising business might be stabilizing, but the company faces too many long-term headwinds, lacks a path toward profitability, and seems like a much riskier play than Meta Platforms right now.