Because at this valuation, investors demand a steady stream of positive surprises to counterbalance its absolute absence of profitability.
While the verdict is still out on whether Snap’s business model has any lasting value, one thing is certain, this stock is already fully pricing any upside potential many times over, and investors should avoid it. Here’s why:
Q4 2019 Results & Guidance: Strong Revenue Growth
First, let's look at the positives.
Snap ended Q4 2019 with revenue growth of 44% and guided Q1 2020 to be up 45% -- showing both sequential and year-over-year growth acceleration.
Snap's CEO Evan Spiegel noted the strong momentum across the board and that Snap's DAUs (Daily Active Users) increased by 17% year-over-year to 218 million in Q4 2019.
Furthermore, Snap highlights that North America DAUs were up 9% year-over-year compared with down 1% in Q4 2018. Also, North America growth benefited from 31% higher ARPUs (average revenue per user) year-over-year, resulting in total revenue growth of 42% for North America.
No Visibility to Profitability
Moving on to the negative attributes, as is common with software companies, Snap’s main cost is in the form of stock-based compensation. What makes Snap stand out is that close to 43% of its revenues are made up of stock-based compensation.
Common sense dictates that manager compensation is the cost of running a software business. Yet, Snap staunchly points investors towards its non-GAAP EBITDA figures instead.
Thus, when Snap guides investors to adjusted EBITDA profitability in 2020, investors should minimally question what does this figure fundamentally encompass?
Consider that 2019's GAAP net income was negative $1 billion off of $1.7 billion in revenues. Put another way, for every dollar of revenue in 2019, Snap had 59 cents in losses -- before accounting for any capital expenditures.
Valuation – No Margin of Safety
In the ideal world, Snap’s app would lay claim to an unbreakable competitive advantage over its key demographic of 13-year olds to 34-year-olds. However, in reality, it does not.
Meanwhile, privately-held TikTok also points to high user engagement metrics, with some figures pointing towards 40+ minutes of daily engagement amongst users.
Why should investors be willing to pay 13x sales for a company with no significant recurring revenues and a fickle user base?
This time last year, when Snap was being valued at less than $12 billion, these arguments would have raised no substantial concerns.
However, given that its stock has been on a tear and soared more than 120% including the recent sell-off, investors are likely to more question whether the stock has any upside left.
The Bottom Line
Snap has fast revenue growth on its side, but given that there are other social media platforms trading more cheaply while being substantially more profitable, shareholders are likely to find themselves having to exit their overvalued Snap investment disheartened.
Ultimately, Snap is priced to perfection with no further upside potential. Avoid this name.