SNAP Stock Has Some Fundamental Issues That Should Worry You

Unless it makes strategic changes, things could get ugly for SNAP

Snap (NYSE:SNAP) doesn’t look bad for a company that often gets lost in the shuffle with Facebook (NASDAQ:FB) and Twitter (NYSE:TWTR) dominating headlines in the social media space. SNAP stock gained close to 11% in value over the last month.

After a stellar first-quarter report, SNAP stock recorded a 36.7% gain, its best performance in two years. The social media company is also close to generating positive free cash flow for the first time in its history, something that warrants celebration.

However, the numbers also indicate that advertising revenues are slowing down and will stagnate further towards the latter half of the year. The youth-oriented demographic profile of its user base is also a problem, as is the Snap’s lack of options to monetize its platform.

All things considered, Snap is the riskiest stock in the social media space at the moment. Unless it makes strategic changes, the stock will continue to lose value moving forward.

A Closer Look at SNAP Stock

Although the first quarter was a good one for Snap, the cracks are there for all to see.

In January and February, the company managed to grow revenues by a solid 58%; however, the figure slowed to just 25% in March. This is important because March is when the novel coronavirus crisis started to affect daily lives in the United States, which is Snap’s base market. Although things are getting back to normal, it’s fair to expect revenues to remain sluggish for the foreseeable future.

Advertising will be a crucial area for Snap to look into if the company wants to remain profitable.

North America remains the primary market for the company. Its success and failure will largely depend on how it does in that territory. The average revenue per user (ARPU), a key metric for success in the social media marketing space, declined in North American and global regions, as per the latest quarterly results. That’s certainly not a heartening sign by any means.

The fast pace of growth of 2019 is unsustainable in my eyes. You certainly won’t see Snap reporting advertising revenue growth in the high 40s at a time when every company worth its salt is reevaluating its marketing spend. Companies with higher historical ROIs are likely to benefit.

In addition, Snap has found it hard to monetize its platform outside of Snapchat Discover — the app’s newsfeed. It won’t be easy for the company to convince others that they need to advertise on their platform when other applications offer greater visibility.

That’s what prompted Citi analyst Jason Bazinet to downgrade the stock. In a note, the analyst mentioned how the market had become “too bullish on both DAU (daily active user) growth and monetization trends,” and how these trends may not be sustainable. Snap stock fell 3% in pre-market trading as a result of the downgrade.

User Demographics Are a Problem

Snap remains a platform for younger people. The user demographic is heavily skewed towards teens. It’s a highly coveted demographic since these users will make up a sizeable chunk of consumers in the future.

However, there are two problems here that need to be addressed. Firstly, youth and advertising revenue do not go hand in hand. According to a report released by 5W Public Relations, millennials hit their prime spending years in 2020. With purchasing power of $1.4 trillion, they remain the most coveted “young” demographic among advertisers.

The report came out in January, and these projections will take a hit due to Covid-19, but the pandemic has not changed vital facts. Snap users are young, but they haven’t hit their prime spending ages. Other platforms like Facebook and Instagram have a slightly older demographic. That means higher spending power.

Another problem that the company has to face is the geographic spread of users. North America is the company’s chief revenue driver by some margin. Globally, the company has not been able to make its mark.

TikTok, a platform that also has a youth-oriented user base, is far more diversified, as an example. It has a massive user base in Southeast Asia, and that will only grow. On the other hand, Snap focuses on high-income countries like the U.S., and while that may not be a bad thing, they are letting go of considerable opportunities in other regions.

Significant Insider Sales

There has been significant insider selling of the company’s stock over the last 90 days. While that is not reason enough to sell the stock, it indicates where the head honchos of the company feel Snap is going. CEO Evan Spiegel and CTO Robert Murphy sold the most stock during this time.

Snap’s Future Rests in the Hands of Its Co-founders

One thing to note here is that since Spiegel and Murphy possess the bulk of voting power in the company, shareholders should be aware that there are limits to what they can accomplish.

Both are co-founders of the company and have a strong vision regarding how to run operations. If you are dissatisfied, there is little that you or an activist investor can do to pivot the company in a different direction.

Last Word on SNAP stock

Social media stocks have bounced back along with the broader markets. The rally is not unexpected, and they will gain further ground in the third and fourth quarters. But Snap is still an outlier in this group. Markets reacted positively to a better than expected earnings report. However, the company’s structural issues remain the same.

Other companies dominating this space offer higher values. The markets will reflect this sentiment once usage statistics release later in the year.

Unless there is a fundamental change in the company’s monetization strategy, its not possible to advocate in favor of allocating more capital to this stock.

Snap is a sell for me.

Faizan Farooque is a contributing author for InvestorPlace.com and numerous other financial sites. He has several years of experience in analyzing stocks and was a data journalist at S&P Global Market Intelligence. His passion is to help the average investor make more informed decisions regarding their portfolio. Faizan does not directly own the securities mentioned above.