Will Snap Stock Continue Its Comeback in 2020?

Snap (NYSE: SNAP) was one of the best-performing stocks of 2019, with its share price more than tripling from its all-time low on Dec. 21, 2018. The stock was fueled by a strong performance from the company turning around user growth, improving margins, and setting itself up for its first profitable quarter on an adjusted EBITDA basis.

Will 2020 be a repeat performance for Snap stock or will it look more like 2018 (when shares fell more than 60%)?

The Snapchat logo

Image source: Snap.

Expectations are much different this year

Heading into 2019, Snap was bleeding Snapchat users following a botched redesign and continuous neglect of its subpar user experience on Android devices. The company walked back some of those redesign changes and launched its rebuilt Android app earlier this year.

The efforts have paid off. The company added 20 million net new daily active users from the end of the first quarter to the end of the third quarter. Management expects to add between 4 million and 5 million more users in the fourth quarter.

The user growth has coincided with accelerating revenue growth. While Snap's top line grew 36% year over year in the fourth quarter of 2018, that number climbed to 50% in the third quarter of 2019. That was fueled by a 33% increase in average revenue per user, with particular strength in North America.

Along with that revenue acceleration, Snap is seeing its gross margin expand. Gross margin reached 51% in the third quarter, a massive improvement from the 36% gross margin it posted in the same period last year. And with the seasonally strong fourth quarter, the company should see a marked improvement once again when it reports earnings in February.

Going into 2020, Snap is firing on all cylinders with faster user growth, revenue growth, and improved profitability. Analysts expect to see revenue growth slow slightly next year, but the consensus is the company will be profitable on an adjusted basis for the full year. That's much different than the outlook analysts had this time last year.

A look at valuation

While Snap is seeing improved profitability, it's coming as a result of growing revenue. To be sure, management is still focused on growing the top line, while expenses like infrastructure costs are a secondary concern. As such, it's best to look at the company's price-to-sales ratio.

Exiting 2018, Snap had a P/S ratio of less than 5.1. That was actually lower than Facebook's (NASDAQ: FB) valuation of nearly six times sales. Investors were expecting Snap's user losses and revenue growth slowdown to continue indefinitely. Meanwhile, Facebook has been fairly steady in adding new users and growing revenue, although its growth rate has slowed as it saturates its ad load in its feed products and battles the law of large numbers.

Over the last year, Snap's P/S multiple expanded to 14.1 times revenue. Facebook also saw a multiple expansion from six times to nine times revenue despite its continued slowdown in revenue growth.

Snap may deserve a premium over Facebook and most other tech companies in the social media and digital advertising industries. It's expected to grow revenue more than 1.5 times as fast as Facebook next year.

But all this is to say Snap stock is valued at a much more appropriate price heading out of 2019 than it was at the end of 2018. It's hard to expect it to further accelerate revenue growth after it laps its user losses from 2018. That revenue growth will become even harder as it moves into the second half of the year and laps its record-breaking second quarter from this year.

Meanwhile, Snap's management will need to continue its solid execution in order to fend off attacks from Facebook, which has proven relentless in its efforts to take engagement away from Snapchat.

So, Snap shouldn't see the same kind of multiple expansion it saw in 2019 again in 2020. And with expected revenue growth in the mid-30% range, the stock should see a much more modest performance.

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Randi Zuckerberg, a former director of market development and spokeswoman for Facebook and sister to its CEO, Mark Zuckerberg, is a member of The Motley Fool's board of directors. Adam Levy owns shares of Facebook. The Motley Fool owns shares of and recommends Facebook. The Motley Fool has a disclosure policy.

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