Snap Inc. (NYSE: SNAP) reports earnings on April 21. Shares have fallen 46% in the past 12 months and nearly 28% so far in 2022. The company is in a tough spot. Even if the number of assets users continues to grow at a rapid rate, with 319 million daily active users in Q4 of 2021 (see slide 5), market conditions are not favorable to this type of business.
Rising rates have hit growth stocks hard due to the disproportionate impact of higher discount rates on net present value. Even though SNAP has moved solidly towards posting positive earnings, the valuation continues to be very rate sensitive. Additionally, the Cathie Wood/”never bet against innovation” narrative seems to have lost its grip on followers who have driven a range of growth stocks to extreme heights (Ms. Wood’s ARKK fund held more than 2.3 million shares of SNAP at the start of 2021).
SNAP’s path to profitability has been consistent and impressive, with 6 consecutive quarters of EPS greater than or equal to zero. With the company expected to report near-zero earnings for the first quarter, it will be interesting to see if investors are shocked by the stark contrast between the fourth and first quarters.
I’ve analyzed a range of stocks that have ignited the public imagination and soared to incredible heights, with little or no worry about the path to profitability. Some of these are large companies that have become speculative favorites as stock prices become decoupled from fundamentals. Teladoc (TDOC) is an example. These types of stocks tend to have certain common characteristics. Even when falling, analysts tend to maintain their favorable views, so expected price targets imply ever-higher returns. Some analysts will break ranks, reducing their price targets, with the result that the gap between individual price targets becomes very large. A third common characteristic of stocks is that option prices signal lottery-like expectations, with a high probability of loss and a low probability of huge wins. I have documented these characteristics for a range of stocks. See, for example, my discussion of TDOC in July 2021 and Robinhood (HOOD) in November 2021, and there are many more examples.
For high-growth stocks like SNAP, the options market provides particularly important information via the implied market outlook. For readers who have not encountered this concept, a brief explanation is in order. The price of an option on a stock reflects the market’s consensus estimate of the probability that the price of the stock will exceed (call option) or fall below (put option) a specific threshold (the price exercise of the option) by the expiration of the option . By analyzing call and put option prices at a range of strike prices, all with the same expiration date, it is possible to calculate a probabilistic price prediction that reconciles option prices. It is the implied outlook of the market and represents the consensus opinion of traders which is reflected in the options market prices. For readers who want a more theoretical explanation of this approach, I recommend this excellent monograph published by the CFA Institute.
I want to invest in SNAP because the company is both innovative and very effective in marketing its products. I’m analyzing SNAP for the first time, now that the shares have fallen significantly. I calculated the implied market outlook for SNAP through the end of 2022 and compared it with the current Wall Street consensus outlook.
Wall Street Consensus Outlook for SNAP
E-Trade calculates the Wall Street Consensus Outlook by aggregating the opinions of 27 ranked analysts who have published ratings and price targets for SNAP over the past 3 months. The consensus rating is bullish, as it has been throughout the past year. The 12-month consensus price target is 59.8% above the current share price. A big red flag here is that there is a very high dispersion in the outlook of individual analysts. The highest price target is 2.6 times the low. A 2019 research paper found that the consensus price target had significant predictive value when the dispersion was low, but there was in fact a negative correlation between the returns implied by the consensus price targets and subsequent performance. when the dispersion was high. In this case, a consensus price target above the current price, combined with high dispersion between individual price targets, is a bearish signal.
Seeking Alpha calculates the Wall Street Consensus Outlook by aggregating the opinions of 40 analysts who have published opinions over the past 90 days. The consensus rating is bullish and the 12-month consensus price target is 63% higher than the current stock price. The dispersion between individual price targets is high, with the highest price target being 2.3x the lowest.
The fact that the consensus rating is still long/bullish and the consensus price target is well above the current stock price is a positive sign. The very high dispersion between the views of individual analysts is a bearish signal. As a general rule, I discard consensus outlooks when the high price target is more than twice the low.
Implied market outlook for SNAP
I calculated the implied market outlook for SNAP for the 2.1 month period to June 17, 2022 and the 9.2 month period to January 20, 2023, using expiring option prices on these dates. I selected these two expiration dates to provide a view through the middle of 2022 and through the end of the year. The January expiration date is closest to the end of 2022.
The standard presentation of the implied market outlook is a probability distribution of price return, with probability on the vertical axis and return on the horizontal.
The implied market outlook through mid-June is biased towards negative returns, with the maximum probability corresponding to a price return of -14%. The expected volatility calculated from this outlook is 82% (annualised). For comparison, E-Trade calculates an implied volatility of 75% for options expiring on June 17.
To make it easier to directly compare the probabilities of positive and negative returns of the same magnitude, I rotate the negative return side of the distribution around the vertical axis (see chart below).
This view points out that the probabilities of negative returns are significantly and consistently higher than the probabilities of positive returns of the same magnitude (the dashed red line is well above the solid blue line across a wide range of the most likely). This is a bearish outlook for SNAP.
The theory suggests that the market’s implied outlook should be negatively biased because risk-averse investors tend to pay more than fair value for downside protection. However, there is no way to measure whether this bias is present. The substantial tilt in this implied market outlook, relative to the range of other companies I have analyzed, is significant enough that I am confident in interpreting this implied market outlook as bearish.
The implied market outlook through early 2023 is qualitatively similar to the shorter-term outlook, although the bearish tilt is even more pronounced. The maximum probability corresponds to a return of -26% over this 9.2 month period and the difference in probabilities between negative and positive returns is significant. This is a bearish outlook until early 2023. The expected volatility calculated from this distribution is 63% (annualized). Although this is still a high level of volatility, the implied market outlook indicates that SNAP’s risk level should decrease.
The market’s implied outlook for SNAP is similar to the results of a range of other high-growth stocks. The most likely outcomes are negative returns, in the near term and through early 2023. There is of course the potential for significant positive returns. The outlook is consistently bearish, with high volatility.
As I indicated earlier, I would like to invest in SNAP and was hoping the stock would look reasonable after the steep declines of the past 12 months. The Wall Street consensus outlook is optimistic, with expected 12-month gains of around 60%. Even with the expected high volatility, this level of expected return would be attractive. The high level of disagreement among analysts, reflected by a wide spread of price targets, however, leads me to discount the consensus outlook. The market’s implied outlook is bearish through mid-2022 and early 2023. I’m rating SNAP as Sell, although I’d be afraid to go short due to very high volatility.