Investor Essentials Daily

This social media giant just passed a major milestone

Snap Inc. (SNAP)
June 8, 2021

Today’s company has done well in the market over the last few days, thanks to it passing a major milestone for the social media industry.

Today, we’ll be looking at if it’s too late for investors to jump in on this fast moving train, or if the market is still expecting returns and growth to improve over the coming years.

Also below, the company’s Uniform Accounting Performance and Valuation Tearsheet.

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Since struggling significantly in recent years, with its stock price falling to just $10 in March of 2020, social media company Snap (SNAP) has rebounded tremendously with a current stock price of roughly $60.

Founded in 2011, Snap’s premier app Snapchat lets users seamlessly send each other pictures. However, it wasn’t until the past year when the company made operational improvements, coupled with its capitalization on secular tailwinds.

One area the company has been able to shine in is its ability to rapidly adapt to an ever-changing market environment.

Additionally, Snap just released a significant new datapoint a few weeks ago. The company crossed over 500 million monthly average users (MAU).

This is an impressive achievement, highly respected by competitors and the company’s customers within the space.

The company was deliberate in leaving out their progress on reaching the milestone until it actually achieved it.

Previously, Snap was heavily focusing on daily average user (DAU) statistics. This particular metric shows a slightly less impressive number.

Specifically, the company’s daily average user rate is currently at 280 million regular users.

However, the market has clearly reacted quite positively to growth in these key metrics over the past year as the stock price has skyrocketed.

The market is especially excited about the company’s growth opportunities and initiatives. Moreover, with fundamentals accelerating, investors may be curious if they should at all be following suit.

In many cases, we often recommend investors not to jump in a trend that the market is clearly pricing in or has already developed positive feelings towards.

In these situations, it is hard to outperform expectations, leaving further equity upside difficult to reach.

So, let’s take a look at this example.

To gain a greater understanding about what the market is pricing in, we can use our Embedded Expectations Framework.

Most investors determine stock valuations using a discounted cash flow (DCF) model, which takes assumptions about the future and produces the “intrinsic value” of the stock.

However, here at Valens, we know models with garbage-in assumptions only come out as garbage. Therefore, we’ve turned the DCF model on its head with our Embedded Expectations Framework. Here, we use the current stock price to determine what returns the market expects.

In the chart below, the dark blue bars represent Snap’s historical corporate performance levels in terms of ROA. The light blue bars are Wall Street analysts’ expectations for the next two years. Finally, the white bars are the market’s expectations for how the company’s ROA will shift in the next five years.

Wall Street analysts are expecting Snap’s Uniform ROA to improve from just 4% levels in 2020 to 25% levels by 2022.

With this forecasted growth, the market is pricing in Uniform ROA to expand even higher to 84% levels by 2025. Paired with 20% growth rates per year, the market is expecting a huge transformation out of Snap.

As our Embedded Expectations Analysis shows, the market is already pricing in a sharply bullish case for the name. For the company to realize any upside, it has to overcome these already lofty expectations.

The market is pricing in ROA to reach robust levels above any other social media company currently, including Facebook (FB).

As a result, we believe it may be worthwhile for investors to stay away from this company for the time being.

SUMMARY and Snap Inc. Tearsheet

As the Uniform Accounting tearsheet for Snap Inc. (SNAP:USA) highlights, the Uniform P/E trades at 143.3x, which is above the global corporate average of 23.7x and its historical P/E of 120.2x.

High P/Es require high EPS growth to sustain them. That said, in the case of Snap, the company has recently shown a 107% Uniform EPS shrinkage.

Wall Street analysts provide stock and valuation recommendations that in general provide very poor guidance or insight. However, Wall Street analysts’ near-term earnings forecasts tend to have relevant information.

Wall Street analysts provide stock and valuation recommendations that in general provide very poor guidance or insight. However, Wall Street analysts’ near-term earnings forecasts tend to have relevant information.

Based on the current stock market valuations, we can use earnings growth valuation metrics to back into the required growth rate to justify Snap’s $61 stock price. These are often referred to as market embedded expectations.

The company is currently being valued as if Uniform earnings were to grow by 104% annually over the next three years. What Wall Street analysts expect for Snap’s earnings growth is above what the current stock market valuation requires through 2022.

Furthermore, the company’s earning power is below the long-run corporate average. Also, intrinsic credit risk is 20bps above the risk-free rate and cash flows and cash on hand are more around 5x its total obligations—including debt maturities and capex maintenance. All in all, this signals a low credit risk.

To conclude, Snap’s Uniform earnings growth is well above its peer averages, and the company is also trading above average peer valuations.

Best regards,

Joel Litman & Rob Spivey

Chief Investment Strategist &
Director of Research
at Valens Research

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