The Hottest Social Media Stock of 2017

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Shares of Facebook Inc (NASDAQ:FB) have more than tripled since the company held its initial public offering (IPO) in 2012. An explosion in profits, not to mention a corresponding rise in Facebook user growth, kept the stock on an upward track.

But now, Facebook is facing the ultimate challenger:Snap Inc.

These two social media stocks are set to collide after the Snap IPO comes to fruition. Many analysts are worried about this Snapchat IPO, because it could potentially harm FB stock, but I’m less convinced. I think the question we should be asking is: should you buy SNAP stock?

Before we get to answering that question, let’s back up a little.

For those who may not know, Snap is the maker of “Snapchat,” a popular video messaging service that is probably keeping Mark Zuckerberg awake at night. It’s hard to blame him; the Snapchat user growth statistics are the stuff of nightmares.

Moreover, its users are younger, more active, and more responsive to ads. Investors learned most of this recently, when documents from the IPO were released in early February.

What they saw was a company with phenomenal growth. The Snap IPO papers revealed revenue growth in the high-triple digits and intense engagement. There were other tidbits hidden in the fine print, but the broad sense was that SNAP stock could soar after the Snapchat IPO. (Source: “Form S-1 Registration Statement,” U.S. Securities and Exchange Commission, February 2, 2017.)

This is hardly surprising.  Anyone that tracked Snapchat’s history in the private market knows its popularity among financiers. Venture capital funds have showered money on Snap for years, mainly because they believe it could be the next FB stock. To them, everything about the Snapchat IPO looks like Facebook circa 2012.

If they’re right, then Snap stock will follow the same trajectory as Facebook stock.

Chart courtesy of StockCharts.com

It’s easy to understand why investors compare the two firms. The resemblance is quite striking. For instance, both founders dropped out of college to build their own companies. Both became billionaires before the age of 25. And both refused to sell their companies.

Zuckerberg famously turned down $1.0 billion from Yahoo! Inc. (NASDAQ:YHOO). In a funny twist of fate, Snapchat CEO Evan Spiegel refused a $3.0-billion acquisition offer from Facebook. History just goes round and round in circles. Now that the Snap IPO is set to become the third-largest tech IPO of all time, behind only Facebook and Alibaba Group Holding Ltd (NYSE:BABA), the comparisons are inevitable.

*estimated value

(Source: “Snap’s IPO could be bigger than Google’s,” Business Insider, October 7, 2016.)

But if this comparison (Snap vs Facebook) holds true after the Snapchat IPO, early investors in SNAP stock will make a fortune. But they don’t have to be the only ones to get rich off this social media giant. Retail investors will get a chance as well, if history is an indicator.

How Snapchat Will Make Money Post-IPO

The chance to invest in SNAP stock is coming soon. But, before you go put your retirement savings into this issue, perhaps you should know how Snap plans to make money.

“We generate revenue primarily through advertising,” wrote Snap in its IPO filing. “We help our advertising partners generate a return on their investment by creating engaging advertising products that reach our large and desirable audience.” (Source: U.S. Securities and Exchange Commission, op cit.)

This business model should look familiar. It’s pretty much what Facebook andGoogle (now Alphabet Inc (NASDAQ:GOOG)) have been doing for years. Even now, five years after entering the stock market, Facebook generates nearly 98% of its revenues from advertising. It keeps promising that “Payments and Other Fees” will become a bigger part of the pie—but it just has not happened.

Snapchat is trying to do the same thing. It is working with publishers to make more and more content to entertain users. It seems to be working, because users open the app an average of 18 times a day. They also spend between 25 and 30 minutes using the app every day. Better still, there are studies that show 88% of Snapchat users are in the demographic sweet spot of 13 to 34. (Source: Ibid.)

While those numbers may sound like gibberish to the layman, they are mouth-watering to anyone who works in advertising. Big ad buyers would cut off their left arm for a chance to reach those consumers, particularly on a platform they seem to love.

Snapchat has done its job in terms of making it a compelling user experience.

Let me put it this way: I read a ton of news in order to do my job, and I found it quite natural to read a news story on Snapchat. It didn’t feel awkward or clunky like, say, on “LinkedIn.” That’s good news.

As a result, I don’t think Snapchat will have any trouble bringing in revenue. Advertising dollars will flow like Niagara Falls once more publishers are using the service.

While the bulk of its revenue will come from advertising, there is some potential for Snapchat in the device market. The company released its first hardware product, called “Spectacles,” in late 2016. It was a pair of data-connected sunglasses that allowed users to take hands-free “Snaps.”

Snap sold the Spectacles through pop-up shops, but it is planning a bigger roll-out this year. We believe there is scope for growth on this front, albeit not to the same extent as Facebook’s virtual reality (VR) division.

Snapchat IPO Is Just Around the Corner

Snap was extremely tactful in its S-1 Filing with the U.S. Securities and Exchange Commission (SEC). The company chose to go public now (far earlier than most analysts expected) because its revenues are currently less than $1.0 billion. This qualifies Snap Inc. as a “growth company” and enables it to avoid some reporting requirements. But we dug through the report for anything useful.

It turns out there is plenty of information that can help forecast the potential of SNAP stock.

For instance, Snap revenues increased 589% between 2015 and 2016. It sold $404.5 billion worth of advertising space in the most previous quarter, a startling sum considering that only a handful of publishers are making content for Snapchat. But can it keep up that growth?

It’s hard to say. Snapchat is pretty far away from making profits, and its IPO documents show that profits may not even be a priority for the firm. Based on certain lines in the S-1, Snap’s executives seem to think they can keep investors happy by continuing to grow.

Are they right? Will investors reward SNAP stock if they keep Snapchat user growth high?

All I can say is this: It worked for Amazon.com, Inc. (NASDAQ:AMZN). Amazon didn’t produce a profit for years. But it did innovate. Amazon grew constantly, and it certainly kept its customers happy. Maybe, if CEO Evan Spiegel is smart enough, he can pull off the same thing.

But let’s be clear about one thing: Facebook didn’t do that. Facebook made profits before becoming a public company and then kept that trend going for the last five years. In the last quarter, for instance, Facebook made $3.57 billion in profit from $8.81 billion in revenue.

It is a cash-generating machine. Just take a look at the financial differences between the companies at the time that they filed for IPOs.

Snap isn’t even comparable to Facebook back then. There’s simply no chance that this company can usurp Facebook’s position in the short, medium, or even long term. FB stock is safe from harm. Any analyst who says otherwise is just suffering from a strong case of recency bias.

Here’s the bottom line: Facebook is, and probably always will be, a better company than Snap.

But that doesn’t answer the question: Should you invest in SNAP stock?

Good companies don’t necessarily make for great investments, and vice versa, so that question is still open. Stock prices move for all sorts of different reasons, and the trick is to find stocks that are trading at a discount.

Conclusion

Snap may not be equal to Facebook as a business, but SNAP stock could potentially outperform FB stock in 2017. It has a novelty factor, for one thing. But there’s more. Snapchat is still experiencing rapid fire growth—the kind normally experienced before startups go public.

This means that retail investors are getting a unique opportunity. This is an early entry point to one of the most exciting companies on the planet, and at a relatively low valuation too. While I remain skeptical that Snapchat poses a threat to FB stock, I do believe that it is a promising investment. Zero-sum games need not apply here.

Advertising spending is set to increase to $767.0 billion by 2020. Better still, mobile advertising is expected to triple by then, meaning that the entire pie is growing. Both Facebook stock and Snap stock can succeed—they don’t need to steal slices of market share from each other.

So imagine doubling your money before the end of the year, because that is the kind of upside we’re talking about. All it will take is some stellar top-line growth to set this stock aflame.

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