Many companies in different industries are suffering in the current economic environment, where elevated inflation and rising interest rates are forcing consumers -- and businesses -- to carefully reconsider their spending habits.
Any company that relies on selling advertising spots to generate revenue has been particularly hard hit, and Snap (SNAP 1.29%) is no different. Put simply, if a business knows its customers are on a tight budget, it won't spend as much money marketing products to them on social media platforms like Snapchat.
Snap's revenue declined in the first half of 2023 as a result. But the company just released its financial report for the third quarter (ended Sept. 30), and it revealed a welcome return to growth. With its stock still trading 88% below its all-time high, here's why it might be time for investors to buy the dip.
NYSE: SNAP
Key Data Points
Snap is investing heavily in improving the advertising experience
Beyond the slowdown in the ad market, Snap is still trying to recover from Apple's privacy changes in 2021, which reduced social media companies' ability to sell highly targeted ads. Snap has been innovating ever since, using advanced tools like artificial intelligence (AI) to help businesses reduce conversion costs and increase their return on investment on the platform.
Plus, Snap continues to develop its unique augmented reality (AR) technology, which is playing an increasingly important role for advertisers. A business can now take a regular photo of a product, and Snap's AR engine will transform it into a Lens that potential customers can interact with. Clothing and accessories, for example, can be "tried on" virtually with the user's smartphone camera. Watchmaker Fossil experienced 80% more clicks on its ads thanks in part to AR Lenses.
Snap's new AI features continue to gain momentum
Without growing user engagement on Snapchat, the above efforts to improve the advertising experience would be meaningless. Snap has introduced a series of AI-powered features this year to transform how users interact with the platform -- and each other.
Its My AI chatbot was developed using OpenAI's ChatGPT technology, and it serves as a personalized virtual assistant to help users pick out gifts for their friends, or find a place to eat. Snap says My AI has become one of the most used AI chatbots in the world, with 200 million people sending over 20 billion messages since it was launched in February.
Then there is Dreams, a new generative AI feature designed to create artificially enhanced images. Dreams can take the user's face and generate life-like digital renders, superimposing them into different fantastical scenarios, whether they want to be a mermaid or a superhero.
These AI tools create new revenue streams for Snap. My AI was initially only available to subscribers of the $3.99-per-month Snapchat+ service (of which there are now 5 million members), and while users get eight free Dreams, they have to pay for each additional render.
Snap's revenue returned to growth in Q3
Investors have been critical of Snap this year. Its main competitor, Meta Platforms, has also suffered from weak economic conditions, but that company's revenue started growing again in the first quarter of 2023.
Snap's revenue shrank by 7% year over year in Q1, and it slumped 4% in Q2. It finally returned to growth in the third quarter with a year-over-year increase of 5%. Snap attributed the result to its efforts to improve the advertising experience, as well as the 250% year-over-year jump in revenue from Snapchat+. As previously mentioned, the service now has 5 million members, but it only launched in June 2022, so it has scaled to that number rather quickly.
Unfortunately, Snap's bottom line remains deeply in the red. The company lost $368 million in Q3, taking its 2023 loss to almost $1.1 billion so far. Snap remains well capitalized, with over $3.6 billion in cash, equivalents, and marketable securities on its balance sheet, so it can afford to maintain a loss for now. But investors should be aware the company will struggle to reach profitability without much faster revenue growth, or without substantial cost reductions, which could hurt its ability to grow at all.
Image source: Getty Images.
Why Snap stock is a buy now
While Snap's financials paint a relatively gloomy picture, here's some really positive news: Snapchat continues to attract users at a robust pace. It ended Q3 with 406 million daily active users, which was a 12% increase versus the year-ago period, and growth in that metric has been a consistent theme this year.
I know what you're thinking: If Snap's user base has grown all year, why did its revenue shrink in Q1 and Q2, and tick up only modestly in Q3? It's because the platform's average revenue per user has been falling on a year-over-year basis for all of 2023. However, it appears to have bottomed out in Q1:
Data source: Snap.
There are a couple of factors to consider. First, the weak ad market has affected how much Snap can charge businesses for ads over the last 18 months. Second, Snap monetizes its U.S. users at a far higher rate than those in Europe and the rest of the world, but three-quarters of its daily active user base falls in the latter two categories.
But on a positive note, the 6% decline in ARPU overall in Q3 was driven entirely by the U.S., whereas Snap's ARPU in Europe jumped 15%, and its ARPU increased 8% in the rest of the world.
I would expect the U.S. ad market to eventually bounce back as pressures from inflation and interest rates ease. Plus, Snap should also see a gradual improvement thanks to its efforts to transform the advertising experience for businesses. In the meantime, it's great news that the company is finding a way to monetize its other users more effectively.
An attractive risk-reward proposition for Snap
As I touched on earlier, Snap stock is down 88% from its all-time high. When the broader environment turns back in the company's favor, the Snapchat platform will be in a position of strength with a record-high number of users, which should drive an acceleration in revenue growth. Given Snap's strong balance sheet, its stock offers a very attractive risk-reward proposition right now.
