7 Social Media Stocks: Buy Or Hype?

Love it or hate it, social media is here to stay. Most of the world is now connected through our phones and computers. We live in a time where politicians, athletes, and celebrities can get a message out to their followers with just a few clicks on their phone.

Social media has changed the way people live.The social media industry has also received a tremendous amount of attention from investors. Are the massive market caps and high valuations in the industry justified, or is this another case of ‘irrational exuberance’?

This article examines  several well-known social media companies in an attempt to determine which, if any, are worth investing in.

Snap Inc (SNAP)

Snap has only been in existence since 2011 and has only been a publicly traded company since March 2017. The company is the maker of Snapchat, one of the most popular social networking apps. Snapchat is targeted towards those in the age range of 18 to 24.

Snap released financial results for the third quarter on October 25. Revenue increased 43% to $298 million in the quarter. The last twelve months have seen revenues grow 53% to $1.1 billion. Snap is not yet profitable, as the company is spending capital at a high rate to help grow its user base. The company had an operating loss of $323 million, but this was a $138 million improvement from the third quarter of 2017. Free cash flow registered a loss of $159 million, but this was a $61 million improvement year-over-year.

Snap, like many social media companies, generates revenue from digital advertisements. The more users a social media platform has, the more it can charge for ads.

SNAP Average Daily Users

Source: Snap Inc’s Third Quarter Financial Results Presentation, slide 9.

One popular way to measure user engagement for social media companies is through their daily average users, or DAUs. Snap’s DAUs grew 5% year-over-year to 186 million. This was, however, the second sequential decline in DAUs quarterly.

While DAUs in North America and Europe were up 3% and 4%, respectively from the same time period in 2017, they were down from the second quarter of 2018. The rest of the world saw an 8% growth in active users and this region was able to maintain its daily users total compared to the previous quarter.

While the decline in sequential engagement numbers is not ideal, average revenue per user is showing signs of strength.

SNAP ARPU

Source: Snap Inc’s Third Quarter Financial Results Presentation, slide 10.

Snap saw a 37% increase in average revenue per user from the third quarter of 2017. On a sequential basis, ARPU grew 14%.North American ARPU, which have accounted for 65%-80% of all revenues since Snap became a public company, saw 20% growth from Q2 2017 and a nearly 19% increase from the previous quarter. European ARPU increased 78% year-over-year and 29% from the previous quarter. The rest of the world, which has represented just a small portion of total sales, saw a 175% increase year-over-year, though sequential ARPU declined almost 13%.

Snap has been able to increase its ARPU while suffering slight declines in daily users. And, as you’ll see, Snap only has a fraction of the number of DAUs that other social media companies have. With a small engagement base, Snap cannot afford to stop growing.

On the positive side, Snap has a very stable daily user base. The reason ARPUs have increased despite declines in DAUs is that 80% of Snap’s users use the app every day, one of the highest rates of engagement among all social media companies. Users outside of North America and Europe largely remain an untapped source of potential users. If the company were to expand aggressively to these markets, they could see an increase in their engagement numbers.

All that said, Snapchat is used by those in a very tight age bracket. If the recent decline in daily active users accelerate, Snap could see its average revenue per user begin to drop as well. The stock has cratered almost 80% from its initial public offering price, but we don’t feel that makes the stock a buy.

Snap is still trading for a price-to-sales (not earnings, sales) ratio of 8.0. Social media industry leader Facebook has a net profit margin of 37.6%. Note that Snap is currently losing money. If Snap were to miraculously become as profitable as Facebook (which is far from likely), the company would be trading for a price-to-earnings ratio of 21.3 today.

Despite massive share price declines, Snap still looks overvalued. Additionally, sequential declines in daily active users show that the company’s massive growth expenditures are not effectively growing the company. We recommend investors avoid Snap until it proves it can grow consistently, be profitable, and trades at a reasonable price-to-earnings ratio.

Twitter (TWTR)

Another young company, Twitter became public on November 7, 2013.Twitter closed its first day of trading at nearly $45 per share. Since becoming public, shares of Twitter have experienced a roller coaster ride. The stock dropped as low as $14 in 2016 and 2017, before rebounding to its current price north of $31. Investors who bought at the on the opening day at its high are still underwater five years later.

Twitter reported third quarter earnings on October 25th. The company earned $0.21 per share, topping expectations by $0.07 and improving 110% from the previous year. Revenue grew 29% to $758 million, beating estimates by $57 million. This was Twitter’s highest ever quarterly revenue total, the company’s third consecutive quarter of 21%+ revenue growth and the highest year-over-year growth since the second quarter of 2016.

Total U.S. revenues grew 32% while international revenue saw a 26% improvement.T witter is truly a global company, with 56% of sales from the U.S. and 44% from international markets. Advertising revenue grew 29% to $650 million, above the market’s expectations of $593 million. Users' engagement with ads increased 50% from the third quarter of 2017 while cost per engagement declined 14%. Data licensing sales were up 25% to $108 million, slightly above what analysts were looking for.

Despite these positives, there are some negative issues investors need to know.

TWTR MAU

Source: Twitter’s Third Quarter Earnings Presentation, slide 4.

Twitter’s monthly active users count is down four million on a year-over-year basis. In addition, the company has seen a drop in active users from the second quarter of 2018. Monthly users in international markets, the bulk of Twitter’s users, have declined almost 3% sequentially.U.S. monthly users have dropped 1.5%.

As you might guess, the story isn’t much better when you look at daily active users.

TWTR DAU

Source: Twitter’s Third Quarter Earnings Presentation, slide 5.

While daily active users have increased 9% from the previous year, this is down from Q3 2017’s growth rate of 14% and below Q2 2018’s growth rate of 11%. While daily users are up, the numbers are not as strong as in previous quarters.

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