Snap’s share price plummeted 43% in a single day after the company announced it was likely to miss its Q2 sales estimate just 5 weeks after issuing this projection in its Q1 earnings.
Other social media stocks were dragged down as investors feared a similar tragedy. The largest of them all, Meta (Facebook) was down 8%, while Alphabet was down 5%.
The question we have now is whether these companies are a decent buy right now or if the headwinds are just getting started.
Snap Q1 earnings
To gain a better perspective, let’s review Snapchat’s Q1 results and Financial Guidance from a month ago.
User Metrics
- Daily Active Users grew by 18% year on year to 332 million.
- Average revenue per user increased 17% year-over-year
Financial Results:
- Revenue increased 38% year-over-year to $1,062.7 million
- Net loss increased to $359.6 million, compared to $286.9 million in Q1 2021
Q2 2022 Outlook
- Revenue growth year-over-year is estimated to be between 20% and 25%
Overall, the result was average, falling short of analyst estimates, as with other social media companies.
And now, with management indicating that revenue will likely fall below the low end of its Q2 2022 estimate range, we are anticipating year over year revenue growth for Snapchat in Q2 2022 to be less than 20%, which is nearly half of its Q1 year over year increase of 38%.
Snap’s Valuation
Snap’s massive decline can be attributed to its high valuation due to its higher growth potential. Unfortunately, as they can no longer fulfil it, their share price has plummeted. Snap’s P/S ratio was roughly 8.1x prior to the dip. With this decline, it is now around 4.6x, which is interestingly close to Meta’s and Alphabet’s 4.2x and 5.2x, respectively.
When compared to its 5-year average P/S of 20.7x, Snap is also at a 77% discount, making it quite tempting.
Time to buy Snap?
Is it, however, safe to invest in Snapchat right now?
Given Snap’s close valuation to Meta and Alphabet in terms of P/S, it appears Snap is a superior choice given its higher growth. However, we must consider whether Snap can regain its prior growth rate. Snap revenue growth rates ranged from 60% to 120% at the peak of the pandemic. Even if we just look at the average since its IPO, the company has grown at a minimum of 40%, averaging 40% to 60%.
Given the current environment, this growth rate may take some time to recover, if at all.
To begin with, from a macro perspective, rising interest rates and slower economic growth are limiting consumer discretionary expenditure. Companies are likewise cutting back on expenditure as we face a downturn.
While other social media companies cannot escape this macro factor too, Snap may have a bigger problem because their advertisers (Walt Disney, Pepsi, McDonald’s) are predominantly there for brand exposure rather than sales conversion (Given Snap’s primary demographic are the younger audiences who does not have access to credit card). In this context, between highly targeted marketing, which Meta and Alphabet can provide, and broad marketing exposure, companies would likely prioritize the former. With that, Snap’s recovery may take some time as macroeconomic variables play out and the economy recovers.
Then there are company-specific factors, such as the iOS update that restricts companies from collecting user data. No good solution has been developed to date, and even big tech like Facebook is still struggling with conversions. So, if Facebook, which presumably has far more resources, cannot overcome this hurdle, how likely is Snap?
Finally, unlike Meta and Alphabet, Snap is still a loss-making business, with negative returns in the majority of its quarters. While its cash flow from operations is positive after deducting non-cash outflows such as stock-based compensation, dilution is nevertheless a cost to shareholders.
Better alternatives to Snap up?
Instead, given the similar valuation, investors interested in social media stocks may be better off focusing on the incumbents, who are far more dominant due to economies of scale and the ability to retain users due to the network effect. Incumbents like Meta and Alphabet have also suffered due to the slowdown, and understandably so. Nevertheless, they may be a safer investment if we want to bet on the recovery of social media companies.
Meta
Let’s start with Meta. This stock has taken a beating in recent months due to sluggish growth. Prior to this, Meta had been growing at a rate ranging from 25% to 40%. However, growth has slowed, with the most recent growth rate being only 6.6%. Moving forward, Facebook expects Q2 revenue to be in the $28-30 billion range, putting its year-on-year growth rate at -1% to 6%.
Similarly, we can call into question if Meta can regain its formal growth rate. Between Facebook and Snap, I believe Facebook has a better chance of accelerating its growth once it addresses the iOS problem. Of course, given Facebook’s sheer size, this growth may have to be temped down.
In terms of competition, Meta’s biggest issue would be TikTok, which has already surpassed 1 billion monthly active users. On the plus side, TikTok, like Snap, targets Gen Z, whereas Facebook and Instagram target Gen X and Gen Y, who conveniently tend to spend more.
Alphabet
Next, Google, the market leader in digital advertising, has seen its share price fall 30% from its high due to the same difficulties outlined above. While revenue increased by 23% year over year in the most recent quarter, analysts predict that growth will drop to 13.2% as revenue from YouTube Ads and Google search continue to decline.
On the bright side, Alphabet has announced a $70 billion repurchase of its class A and class C shares. This could be an indication that the management perceives its stock is undervalued.
Aside from YouTube and Google Search, Alphabet also has Google Cloud, which helps to diversify its revenue slightly.
Challenges
Of course, that is not to imply that none of these companies is immune to the challenges Snap is facing.
As advertisers cut back on their spending, the recession would undoubtedly slow Meta and Alphabet’s growth. However, as previously stated, Meta and Alphabet have a much more targeted advertising platform and would be less impacted.
Similarly, Facebook is attempting to overcome the iOS update, and we will have to wait for future earnings to see how well they have fared. So far, things aren’t looking good.
Finally, Meta has declared that it will invest at least $10 billion per year in Reality Labs, its foray into the metaverse. This is a significant investment, accounting for around one-quarter of the company’s net earnings every year. This initiative, whether successful or not, will continue to bleed Meta for years to come.
In summary, all of these are important obstacles that you should be aware of if you decide to invest in these stocks. However, if you want to invest in social media stocks, Meta and Alphabet may be better alternatives.
