No, You Shouldn’t Buy Snap (Snapchat) Stock

No you should not buy Snap (Snapchat) stock. It clearly isn’t a good investment. And it’s not because the founders are young and inexperienced (Zuckerberg is killing it right now as a public company CEO). It isn’t even because the company hasn’t yet made a profit (neither has Amazon). Nor that it is because the company is issuing shares with no voting power, the fact that it’s battling increased competition (thanks to Instagram) or that is is going through an identity crisis (in case you didn’t know, it’s a camera company now).

All of that matters but it’s not the reason why I wouldn’t invest in Snap.

The reason I wouldn’t invest in Snap is PRICE.

Investors are paying more than 50x last year’s revenue, which is more than twice the price of Amazon and Google’s IPO and higher than the IPO price of Twitter, Facebook and Microsoft.

To better understand this, let me explain what “price” really matters.

When you buy stock, you’re buying a claim to the underlying company’s future profits. The expectation of the amount of future profits (growth) and the probability of the company realizing those profits (idiosyncratic risk) help determine the price of shares today. Because of these factors, it is best to think of the cost of an investment not as the actual dollars paid per share (which isn’t usually important) but the amount of money you’re paying per $1 of future cash flow.

One way to do this is to consider the company’s price-to-earnings ratio. For instance, Apple is currently trading at a 16.4 times last year’s earnings, or a P/E ratio of 16.4, meaning investors are paying $16.40 for every $1 of Apple’s earnings. It also means that if Apple’s earnings stayed constant, you would theoretically make your money back in 16.4 years (companies grow and reinvest money so don’t take this example literally).

The faster a firm is expected to grow its earnings, the higher a price investors are willing to pay for it. For example, when Apple was young and had more opportunities to grow, investors were willing to pay as high as $35 per every $1 of Apple’s earnings. While this was a higher price than many other tech companies, it turned out to be a good decision.

Sometimes, for young companies that aren’t yet profitable, investors substitute earnings for sales, assuming that the company will eventually turn profit. This is one way that investors are valuing Snap. Young companies like Snap generally have a lot of untapped growth opportunities and investors are willing to pay more since they expect high future growth. But how much growth would Snap truly need in order for an investor, paying $58.8 per $1 of sales, to create a strong return?

A shit ton.

Without getting into the details, for Snap to turn out to be a good investment, it needs to perform similarly or better than the companies listed above (less Twitter, which didn’t turn out to be a good investment). Do you see that happening? If not, don’t invest in Snap. If you do, do more research, sleep on it and hopefully, you’ll come to your senses.

Aside from its price, the other thing that bothers me is the lack of voting rights. It’s a common thing today amongst tech companies. Mark Zuckerberg controls 60% of Facebook’s voting rights, and co-founders Sergey Brin and Larry Page together control 52% of Google’s (Alphabet) voting rights.

SNAP’s founders Evan Spiegel and Bobby Murphy will control about 88.5% of the company’s voting rights.

This means that every major decision from now on rests with these two individuals. If you’re an investor in Snap, you’re trusting these guys won’t fuck up.

But, in the end, attaching a high price and lack of voting rights to shares of a dying company isn’t enough to keep investors away. It seems like wealthy individuals are begging to be a part of this whole mess. Its underwriters (led by Morgan Stanley) did a great job winning the business from Snap’s board of directors, likely by proposing the highest valuation (so the founders could make the most money). They did even a better job of selling an underperforming (possibly dying) company to its investors.

So who wins? Morgan Stanley, its underwriting syndicate and Snap.

Who loses? Individual investors.

Buffett said in his recent shareholder letter “When a person with money meets a person with experience, the one with experience ends up with the money and the one with money leaves with experience.” This wisdom can’t be any more relevant to Snap’s IPO.

Disclaimer: This article IS NOT investment Advice.This document is for information and illustrative purposes only and does not purport to show actual results. It is not, and should not be regarded as investment advice or as a recommendation regarding any particular security or course of action. Opinions expressed herein are current opinions as of the date appearing in this material only and are subject to change without notice. Reasonable people may disagree about the opinions expressed herein. In the event any of the assumptions used herein do not prove to be true, results are likely to vary substantially. All investments entail risks. There is no guarantee that investment strategies will achieve the desired results under all market conditions and each investor should evaluate its ability to invest for a long term especially during periods of a market downturn.