How Much Does Snapchat’s Valuation Matter?

Snapchat’s valuation has been the subject of a lot of handwringing since its ballyhooed IPO last week. But sometimes, valuation can be a bit overblown on Wall Street.

We in the financial media devote a lot of ink to breaking down whether a stock is undervalued or overvalued based on its price-to-earnings ratio, price-to-sales ratio, PEG ratio, etc. Through that value investing lens, you can identify which stocks are ready to explode and which are due for a pullback. Roy Ward, editor of our Cabot Benjamin Graham Value Investor advisory, has used that strategy to near-perfection over the last two decades, as his longtime subscribers would attest.

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But certain stocks defy the laws of market physics, and continue to rise for years with impunity. Just look at Amazon.com (AMZN), which debuted at $1.50 in 1997 and advanced to $93 within its first decade of trading despite failing to turn a profit in any of those years. Tesla Motors (TSLA) is another example, a stock that has risen more than seven-fold since 2012 despite being in the red every year. Tesla’s P/E ratio has had a minus in front of it since the company came public in 2010, but that’s never stopped investors from buying it.

Snapchat’s Valuation in Context

Is Snap Inc. (SNAP) getting the same treatment? Is the stock free to keep motoring higher no matter how overvalued it’s been since the get-go? As of this writing, with a market cap of $32 billion (and rising), Snapchat’s valuation exceeds the likes of Target (TGT), CBS Corp. (CBS), Chipotle (CMG), Hershey (HSY), Yum! Brands (YUM) and Wynn Resorts (WYNN). Unlike those companies, Snapchat has never made a penny from its popular photo- and video-sharing application. But Snapchat excites people, millennials in particular, and Wall Street is tapping into that potential, drinking the Kool-Aid of the company’s promises of what’s to come.

Perhaps they’re right. Then again, for all the exceptions to the rules of stock valuation over the years, market history is littered with probably 10 times as many (or more) stocks that have succumbed to it. Look no further than Snapchat’s social media counterpart, Twitter (TWTR).

Twitter exploded out of the gates too, coming public at 41 in November 2013 and kiting to 69 in less than two months. Then, reality set in: investor excitement waned, the company reported another quarter of significant losses, and TWTR stock plummeted to 30 by May 2014. It currently trades at half that share price, and hasn’t been higher than 23 since 2015.

Soon enough, the early excitement over the Snapchat IPO will fade too, and those who bought Snap will take a long, hard look at the stock. Given Snapchat’s valuation and no profits in sight for the next two years, they may not like what they see.

SNAP the Next TWTR?

Only a select few companies manage to defy the value investing gods—companies like an e-commerce giant that revolutionized the way Americans shop, or a luxury electric-car maker that allows you to bypass the dealership. Is Snapchat that type of revolutionary company? I have my doubts.

Right now, Snap stock looks a lot like Twitter stock did in its first week of trading. Two months from now, it may still look like TWTR … and not in a good way. Chances are, Snapchat’s valuation will be its undoing.

Chris Preston

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Investment analyst and Chief Analyst of Cabot Wealth Daily, Chris Preston brings you all the latest from the investing world. Sign up to get updates and breaking news delivered FREE to your inbox. Get unlimited access to our library of complimentary investing reports.

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