The 1 Tech Stock I'd Never Put in an IRA
Investors can put a wide range of investments -- including stocks, bonds, index funds, mutual funds, and ETFs -- into their IRAs. Financial advisors usually suggest sticking with conservative, income-generating stocks that will benefit from the long-term compounded growth of reinvested dividends.
However, younger investors can also put a few speculative stocks in their IRAs, since a single multi-bagger can more than offset a few losers. However, there's one speculative tech stock that I'd avoid putting in an IRA, even for younger investors: Snap (NYSE: SNAP), the maker of the ephemeral messaging app Snapchat.
How does Snap make money?
Snap generates most of its revenue by selling several types of ads on Snapchat -- including web view ads (which let users visit a site without leaving the app), app-install ads, promoted articles for its Discover tab, video ads, sponsored geofilters (based on a user's location), and sponsored lenses.
Snap recently switched over to programmatic (automated) ad purchases. This brought more advertisers to the platform, which offset its lower prices for individual ads. Snap is also partnered with several media companies to produce exclusive shows for Snapchat.
Snap measures its growth in daily active users (DAUs) and average revenue per user (ARPU). Last quarter, its DAUs rose 18% annually and 5% sequentially to 187 million, as its ARPU grew 46% to $1.53. Those figures marked an acceleration from its 17% annual growth in DAUs and 39% ARPU growth during the third quarter.
As a result, Snap's revenue jumped 72% annually during the quarter and 104% for the full year. Analysts expect its revenue to rise another 61% this year and 52% next year.
Why is Snap a lousy IRA stock?
Those revenue growth figures look rosy, but Snap is also deeply unprofitable. It racked up a non-GAAP net loss of $712 million last year, compared to a net loss of $466 million in 2016.
On a GAAP basis -- which includes the $2.6 billion in stock-based compensation (SBC) Snap awarded its executives after its IPO -- Snap posted a net loss of $3.4 billion in 2017, compared to a loss of $515 million a year earlier.
Analysts at Raymond James expect Snap's SBC expenses to drop to $900 million this year, but that still represents over two-thirds of its projected annual revenue of $1.3 billion.
Unless Snap reins in its SBC expenses, it will keep burning through its cash, which was drained by a negative free cash flow of $197.2 million last quarter.
Snap doesn't expect to achieve profitability anytime soon, so the only way to measure its valuation is with its price-to-sales ratio. Unfortunately, Snap's whopping P/S ratio of 26 is double Facebook's (NASDAQ: FB) P/S ratio of 13, and more than triple the industry average of 7 for internet information providers.
Snap is also in the crosshairs of Facebook's Instagram, which surged past 500 million DAUs last September and liberally "borrowed" features from Snapchat -- including its ephemeral messages, "stories", and filters. Unlike Snap, Facebook's core business is highly profitable -- so it can keep pouring money into Instagram until it runs Snapchat into the ground.
Lastly, Snap gained momentum over the past few years on the shoulders of younger users who shunned Facebook as their parents signed up. But Instagram is still popular with teens, while Snap's recently redesigned app upset a lot of its core users. Therefore, Snapchat's growth could peak as its core base of fickle teen users shuffles away.
The key takeaway
Snap might rally over the next few quarters as investors get excited about it again, but I have too many concerns about its long-term growth. That's why I'd never put shares of Snap in an IRA -- its gains might be as ephemeral as its self-destructing messages.
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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.