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Snap: 5 Reasons to Buy, 5 Reasons to Avoid

Shares of Snap (NYSE: SNAP) recently surged after the company's fourth quarter numbers beat analyst expectations on the top and bottom lines. That rally lifted the stock back above its IPO price of $17, a level which it hasn't seen since last July.

I've been bearish on Snap ever since its market debut last March due to its sluggish user growth, tough competition from Facebook's (NASDAQ: FB) Instagram, widening losses, high stock-based compensation expenses, and negative free cash flow.

Nonetheless, let's dig deeper into Snap's fourth quarter numbers to see if this hated social media stock has finally reached a turning point. I'll highlight five reasons to buy Snap, and five reasons to avoid it.

5 reasons to buy Snap

  • Snap's revenue rose 72% annually to $285.7 million during the quarter, topping estimates by nearly $33 million. That also marked an acceleration from its 62% growth during the third quarter.
  • Its daily active users (DAUs) rose 18% annually and 5% sequentially to 187 million, beating analyst expectations by three million. More importantly, those growth rates were faster than its 17% annual and 3% sequential DAU growth rates during the third quarter.
  • Snap's average revenue per user (ARPU) rose 46% annually to $1.53. This also marked an acceleration from its 39% ARPU growth during the third quarter. CEO Evan Spiegel attributed that growth to the recent redesign of Snapchat, improvements for Android users, and a switch to programmatic (automated) ad buys, which attracted more advertisers and offset lower ad prices.
  • Snap's cost of revenue per user rose 5% annually to $1.02, but that remained lower than its ARPU and represented a 14% decline from the third quarter.
  • Its non-GAAP net loss narrowed slightly from $158.3 million to $156.1 million. On a per share basis, its loss narrowed from $0.19 per share to $0.13 per share.

5 reasons to avoid Snap

  • Unfortunately, Snap is still rewarding itself at the expense of its shareholders. It reported $181 million in stock-based compensation expenses during the fourth quarter, compared to just $6.8 million in the prior year quarter.
  • Snap's GAAP loss, which excludes those generous stock-based compensation expenses, widened from $169.9 million in the prior year quarter to $350 million. It also posted an adjusted EBITDA loss of $158.9 million, compared to a loss of $152.2 milion a year earlier. Snap still hasn't presented investors with a long-term roadmap toward profitability.
  • Snap is still burning through its post-IPO cash. It's had a negative free cash flow of $197.2 million for the quarter, compared to negative $188.1 million a year earlier.The company finished the year with $2.04 billion in cash, cash equivalents, and marketable securities, compared to $987 million at the end of 2016 -- but investors should remember that it raised $3.4 billion during its IPO last March.
  • Snap's user growth still pales in comparison to Instagram's, which hit 500 million DAUs last September -- up from just 150 million DAUs at the beginning of 2017. Instagram's introduction of Snapchat-like features, including ephemeral messages and photos, filters, and "stories", could throttle Snapchat's growth for the foreseeable future.
  • At $20, Snap trades at about 30 times its 2017 revenues. That's a very lofty valuation for a company, even though analysts expect it to generate more than 50% annual sales growth over the next two years. By comparison, Facebook -- which is expected to post 36% sales growth this year -- trades at 15 times sales. However, Facebook is also profitable, and its forward P/E of 21 doesn't look expensive compared to its estimated earnings growth of 34% this year.

The verdict: Better, but not good enough

Snap made some solid improvements during the fourth quarter, but too many of its old problems remain. It remains overshadowed by Instagram, its GAAP losses are still widening, it's burning through a lot of cash, and the stock still has an astronomical valuation.

Therefore, this isn't an ideal stock to own as the lofty market teeters toward a long-overdue correction. Investors who are looking for a solid social networking play should stick with Facebook instead.

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Leo Sun has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Facebook. The Motley Fool has the following options: short March 2018 $200 calls on Facebook and long March 2018 $170 puts on Facebook. The Motley Fool has a disclosure policy.