There’s a great deal to like about Snap (NYSE:SNAP). Specifically, the company’s first-quarter results indicate that it is finally starting to benefit significantly from rebounding U.S. advertising spending, and its user metrics were very strong in the first quarter. Moreover, Snap is well-positioned to benefit a great deal if TikTok does wind up getting banned in the U.S. Still, given the year-over-year declines of some of the firm’s profitability metrics, along with the high valuation of SNAP stock and the company’s past struggles, I recommend that investors sell the shares into their recent strength.
Impressive Q1 Results and Potential TikTok Catalyst
As I noted in a May 8 column, analysts are raising their 2024 revenue estimates for the U.S. advertising market, and the sector is expanding quite rapidly. As I pointed out in the article, “research firm IPG Mediabrands last month raised its forecast for the U.S. ad market’s growth to 9.2% from its previous 8.4% estimate. “
Snap is clearly benefiting from the sector’s strength as its revenue climbed 20% last quarter versus the same period a year earlier to $1.195 billion while its EBITDA, excluding certain items, came in at $46 million, up from $1 million in Q1 of 2023. Further, there were 85% more small-and-medium advertisers on Snapchat last quarter than in Q1 of 2023.
And the firm reported several positive user metrics. For example, its daily active users increased 10% year-over-year (YOY) to 422 million and the number of subscribers to its Snapchat+ paid content service “more than tripled year-over-year” to over 9 million.
Meanwhile, legislation passed by Congress and signed by President Joe Biden will reportedly force TikTok to either sell its U.S. business or face a ban in America. Since TikTok is very popular among the young Americans that Snapchat targets, Snap’s social media offering is likely to get a huge boost if TikTok is banned.
Profitability Declines and Past Poor Performance
Despite the increase in Snap’s adjusted EBITDA, its operating cash flow actually fell to $88 million last quarter, versus $151 million in Q1 of 2023. Similarly, its free cash flow declined to $38 million from $103 million in the same period a year earlier.
And the company’s cash outflows have undermined its balance sheet. Specifically, in March 2023, it had net cash of $250 million, while a year later it owed a net total of about $400 million. As Seeking Alpha columnist Michael Wiggins De Oliveira noted, the impairment of the firm’s balance sheet will undermine its ability to raise money and buy back its own shares going forward.
Also making me reluctant to recommend Snap is the fact that it has performed very well in the not-too-distant past, only to report horrible quarterly results soon afterwards.
For example, SNAP stock soared 89% in 2023, but in February 2024, the firm reported lower-than-expected Q4 revenue, triggering a huge decline by the shares. And after rising to $83 in September 2021 from $14 in June 2019, SNAP stock tumbled 81% in 2022.
In light of the name’s past volatility, I suggest waiting awhile before buying the shares to ensure that the company’s Q1 results are not just a positive blip.
Valuation and the Bottom Line on SNAP Stock
Annualizing Snap’s Q1 free cash flow of $38 million gets us to $152 million. Given the company’s market capitalization of $25.6 billion, the shares are changing hands for 168 times the company’s annualized free cash flow. That’s a stratospheric valuation.
In light of the company’s erratic performance in the past, the YOY declines of its cash flow last quarter, and the tough competition that it faces in the digital ad market from Meta Platforms (NASDAQ:META) and other large firms, that price is simply excessive.
On the date of publication, Larry Ramer did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines