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Why Investors Should Heed Snap's Warning

Snapchat's parent has issued a warning for ad-dependent tech stocks. Here's why investors should pay attention.

Shares of social media company Snap  (SNAP) - Get Snap Inc. Class A Report plunged more than 40% this week after CEO Evan Spiegel warned of slow growth and the company's management slashed its already depressing guidance.

What message should tech investors take from these warnings?

Figure 1: Why Investors Should Heed Snap's Warning

Figure 1: Why Investors Should Heed Snap's Warning

(Read more from Wall Street Memes: GameStop Stock: 3 Reasons To Buy Before June)

Snap Slashes Guidance

Snap, the parent company of Snapchat, cut its quarterly forecast on Monday due to a worse-than-anticipated economic downturn last month. In a statement, management wrote, "We believe it is likely that we will report revenue and adjusted EBITDA below the low end of our Q2 2022 guidance range."

The statement also remarked that Snap is strongly impacted by rising inflation, as well as by supply-chain and labor disruptions. Changes in platform policies and the impact of the Ukraine war have also hurt Snap's forecasts.

Due to macroeconomic uncertainties, Snap wrote that it will be forced to cut back on hiring this year and that it will consider a better use of the company's budget to find additional cost savings.

Sending a Message

Snap's lowered guidance dumped a bucket of cold water on U.S. growth and tech stocks. The sector had begun to show signs of a recovery from the current bear market.

Snap is a major social media company with a market cap above $35 billion. And its warnings sent a clear message to other companies whose revenues depend on an advertising model.

This was probably the reason for the parallel sell-off at big techs Meta  (FB) - Get Meta Platforms Inc. Report and Alphabet  (GOOGL) - Get Alphabet Inc. Report. Their advertising businesses represent 97% and 82% of their revenues, respectively. During pre-market trading on Tuesday, Meta fell by as much as 7%, while Alphabet saw a 3% dip.

Shares of tech and growth companies have been among the stocks hardest hit by recession fears, high inflation, and other macroeconomic headwinds.

Invesco QQQ QQQ, the ETF that tracks the tech-heavy Nasdaq 100, is already down 27% in 2022 alone.

Snap's revised guidance sent an important message to investors that the scenario for ad-based tech companies is still far from favorable. And that could hurt the long-term growth of these companies — especially social media companies that trade at high multiples.

What's Next for SNAP?

Today, 99% of Snap's revenues are committed to advertising. Its business is dependent on successful product development to sustain the value of its advertisements and keep its users active and growing.

In Q4, Snap was profitable for the first time — but it followed up this victory with a 2-cent-per-share loss in Q1. For Q2, the estimate is that Snap will report an 87% year-over-year drop in earnings per share.

Snap's business has relied on sustained user growth. Last quarter, Snap reported its daily active users (DAUs) had increased by 18% year over year, to 332 million.

Fears over macroeconomic uncertainties once again have put into question whether Snap's trading at a forward price-to-earnings of 69 times — which represents a 307% difference from the industry average — is really anything close to its intrinsic value.

Thanks to Snap's high multiple and low profitability, investors may want to avoid Snap shares for the time being. In the short-to-medium term, things may get worse before they get better. 

(Disclaimers: this is not investment advice. The author may be long one or more stocks mentioned in this report. Also, the article may contain affiliate links. These partnerships do not influence editorial content. Thanks for supporting Wall Street Memes)