FA Alpha Daily

The market is betting that this growing social media company is going to collapse

The COVID-19 pandemic had a mixed impact on businesses and industries, with social media companies benefiting from the increased screen time of people who were staying home. The pandemic revitalized Snapchat, which was struggling to attract new users before the pandemic, as it provides a platform for new content creators to emerge and attract followers. While the market is pricing Snapchat as if it would struggle like it did before the pandemic, the company is still growing and profitable. In today’s FA Alpha Daily, let’s look at Snapchat using Uniform Accounting and see what makes it a good investment opportunity.

FA Alpha Daily:
Tuesday Company Specific
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We see the rise and fall of certain online platforms as times change. Platforms such as Vine, Periscope, and Tumblr have fallen out of favor.

Investors pay close attention to these platforms’ growth. Once they stop growing, they lose their attractiveness.

Snap’s (SNAP) flagship app, Snapchat, looked like it was going to be one of these platforms back in 2018. After reaching 191 million daily active users (“DAU”) in the first quarter of 2018, growth stagnated. By the end of the year, the app was down to 186 million DAU.

This is awful news for a social media company. It relies on its network effects, and Snapchat’s network seemed like it was weakening.

However, the pandemic changed everything… It left almost everyone at home with little to no contact with the outside world for several months.

With life more boring than ever, people sought new products to experiment with to at least bring some joy to being in lockdown.

Without being able to go out and shop in physical stores, many relied on e-commerce to do their shopping. Thus, companies like Amazon (AMZN) and Shopify (SHOP) saw their revenues and share prices skyrocket.

Similarly, social media saw a big uptick in profits and share prices as it was a great way to connect with family and friends without being in person.

Snapchat was one of them. DAUs started climbing again, reaching 265 million by the end of 2020.

Its share price jumped 630% from the beginning of 2020 to September 2021 as investors realized that they were wrong and that Snapchat wasn’t done with growth.

However, since those highs, Snap has seen a decline of about 90% in its share price.

This is despite the fact that the company’s user count keeps growing.

The company is still showing astounding growth even though the heyday of its pandemic performance is behind us.

It’s still growing immensely, and its asset growth in 2022 was higher than that in 2018.

Take a look…

With the addition of Snapchat+, which is a new subscription service that gives users a variety of new features, Snap is now diversifying its revenue streams.

The company has already added 4 million subscribers since the launch date last year.

In the second quarter of 2023, Snap reported a worldwide daily user count of 397 million, marking a 14% growth from the previous year. This means that, compared to the same timeframe in the preceding year, 50 million new users have embraced Snap’s platform.

This underscores to stakeholders that Snap’s momentum remains unhindered, even with the emergence of competing short-form video applications, such as TikTok.

This growth has translated into a strong return on assets (“ROA”) performance as well. Snap’s ROA averaged 77% between 2019 and 2021. Despite advertising setbacks in 2022, the company has managed to remain incredibly profitable, at nearly 40% ROA in 2022.

The chart shows that the company has been performing incredibly well. Coupled with their asset growth and user growth, Snap stands to benefit from all these tailwinds.

And yet, the market fails to recognize this opportunity.

We can see this through our Embedded Expectations Analysis (“EEA”) framework.

The EEA starts by looking at a company’s current stock price. From there, we can calculate what the market expects from the company’s future cash flows. We then compare that with our own cash-flow projections.

In short, it tells us how well a company has to perform in the future to be worth what the market is paying for it today.

At the current stock price, the market expects the company’s ROA to fall to 11%.

Investors think Snapchat is doomed to lose its competitive advantage.

However, plenty of people are still using the app, with user growth increasing substantially over the last year. It’s still growing immensely and continues to show its profitability with high ROA figures.

So far, it has not shown any signs of slowing down. If it can keep growing while keeping ROA where it is, the stock may not deserve to be as cheap as it is. 

Ultimately, the company has substantial upside for a company that the market deems as collapsing.

That is why Snap showed up on our screen. The company makes a great FA Alpha 50 name due to its potential for high returns and low expectations from the market.

Throughout financial market history, many of the world’s most successful investors have been candid in their belief that Generally Accepted Accounting Principles (“GAAP”) distort economic reality.

Warren Buffett, for example, once said investors should “concentrate on the world of companies, not arcane accounting mathematics.”

Investors who neglect the very real issues with as-reported accounting can find themselves caught up in investing with the crowd, blindly following hot “themes” without a thorough grasp of how to understand the businesses in question.

The only true way to focus on the “world of companies,” as Buffett suggests investors do, is to present a clear picture of how a business operates, something that can only be done by adjusting financial statements to reflect the arbitrary nature of certain accounting rules that leave much to discretion.

The world’s best investors understand the need to make these adjustments, which allows them to focus not on picking out the most popular companies but rather on looking for great names in sleepy areas that the market isn’t paying much attention to. From there, the goal is to then identify quality companies with significant growth potential at reasonable prices.

That’s exactly what we’ve set out to do with the FA Alpha, our monthly list of 50 companies that rank at the top for quality, high growth, and low valuations.

This list has outperformed the market by 300 basis points per year for over 20 years now, effectively doubling the performance of the market by focusing on the real fundamentals and valuations of companies with our proprietary Uniform Accounting framework.

See for yourself below.

To see the other 49 names on the list, click here.

Best regards,

Joel Litman & Rob Spivey

Chief Investment Strategist &
Director of Research
at Valens Research

Today’s highlight, Snap Inc. (SNAP) is one of the top stock picks from FA Alpha 50 this month. To see more stock picks like this, become an FA Alpha and get access to FA Alpha 50.

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