Reddit, Inc.'s (NYSE:RDDT) stock has been on a rollercoaster ride since the company was listed as a public entity in March. First, speculative trading regarding its fair IPO price took place. Soon after, Reddit achieved a Q1 earnings surprise, leading to fierce debate on Wall Street. And, most recently, the return of the meme stock crowd has introduced a new set of talking points.
The question now becomes: How do we assess Reddit's long-term prospects, given its intermediate frictions? We argue that Reddit is a stock that will be subject to perpetual event-based trading. However, we also argue that bad and good news will iron out market inefficiencies in the long run, enabling Reddit to eventually reach a fair price.
Here are a few considerations if you're interested in Reddit's stock.
Assessing Reddit's Recent Performance
As previously mentioned, Reddit was listed as a public company in late March (March 21). Its stock traded mixed and maxed, but only gathered steam after the company beat its first-quarter revenue target by $29.02 million on May 7th. The beat led to a surge in Reddit's stock price, setting the platform for a meme stock frenzy.
A meme stock entourage arrived at the stock market's doorstep after renowned meme trader "Roaring Kitty," aka Keith Gill, tweeted a cryptic message a few days ago, involving a sketch of him showing interest in a screen. This was his first tweet since 2021 and, therefore, triggered a resurgence in GameStop (GME) and other meme stocks, including Reddit.
The diagram below shows Reddit's performance in the past week.
I tested Reddit's correlation to GameStop and Reddit. The correlation reveals a coefficient of 0.54 since May 5th. Although not overly convincing, some quantitative evidence exists that the Meme stock crowd's resurgence has led to a surge in Reddit's stock price.
It is impossible to say whether the meme stock resurgence will be long-lasting. In our view, high interest rates mean margin utilization will likely be lower than it was during 2021's meme stock frenzy. Moreover, many investors were burnt by the meme stock's collapse during the 2022 bear market. As such, we think investors should see this as noise more than anything, especially for Reddit's stock, which, isn't directly in the line of focus like GameStop.
Reddit stock's recent performance instills confidence that we can traverse into a fundamental analysis.
Reddit's Fundamentals
How does Reddit make money?
Reddit is a 19-year-old website blog renowned to many. Its high traffic allows it to monetize its website through advertising revenue and data licensing. The former is straightforward; it simply refers to Reddit charging advertisers for exposure. However, the latter is opaque to many. Data licensing refers to the resale of data. Reddit resells most of its data to artificial intelligence companies seeking an understanding of modern-day readers' sentiments.
Key Metrics
Rising volume
Reddit's traffic is the kingmaker in its business model, as it dictates Reddit's pricing ability in the advertising market. Moreover, higher volume results in more attractive data licensing deals as it provides buyers with more comprehensive datasets.
As shown in the following diagram, Reddit recorded 82.7 million daily active users during its first quarter, a 37% year-over-year increase. The rise in Reddit's traffic is partially due to secular growth within its industry. However, the company's anonymity-based business model provides a novel user experience, concurrently adding idiosyncratic support behind Reddit's operating framework.
Reddit's geographic traction is evenly split between U.S. and international users. The firm's first-quarter year-over-year U.S. user growth of 45% outpaced its international growth by a net 15%. Reddit's international expansion is central to its corporate growth strategy. In fact, it recently introduced an AI language tool to its platform, allowing readers to translate threads.
A higher international presence opens up a broader end market for Reddit. We believe that expanded reach will increase Reddit's data licensing profits. However, advertising conversion remains speculative due to a lack of indicators supporting a cost/benefit analysis.
Revenue and the Cost thereof
Assessing a business' traction is one aspect. However, delineating the traffic and its contribution to a firm's income statement is another concept altogether.
According to its first-quarter results, Reddit generated approximately $2.94 per unique user at a gross profit margin of 88%, translating into quarterly revenue of $243 million. Reddit's revenue has surged by 48% year-over-year, communicating the scalability of its concept.
Despite its comprehensive top line, Reddit posted a GAAP-adjusted loss in its first quarter. Reddit's net loss of $575.1 million was primarily driven by stock compensation and taxes. Most of its quarterly stock compensation was linked to the company's IPO. Therefore, lower operating expenses will likely occur in Reddit's following fiscal quarters. Nevertheless, Reddit's research and development charges could remain elevated due to the competitive nature of its industry.
Financial Health and Future Plans
Reddit's operating loss dictates analysis of its balance sheet and plans to assess whether the company will deliver value to its shareholders.
The firm has about $1.67 billion in short-term liquidity on its balance sheet, mainly due to its IPO. The company's prominent cash position mitigates solvency risk and allows for aggressive Research and development spending. Moreover, Reddit's cash position protects against financial tail risk, adding a safety hazard to its stock price.
A substantial cash position isn't enough to achieve future profitability. Thus, Reddit plans to transition its verticals by implementing efficiency initiatives. One such initiative is free-form ads, which Reddit forecasts will outperform traditional ad click-through rates by 28%. Additionally, we believe Reddit's data licensing prices will be marked up in the event of successful international expansion.
Although nothing is for certain, Reddit's balance sheet and key initiatives suggest an enhancement in shareholder value is on the horizon.
Valuation and Technical Analysis
The sections above established a fundamental baseline for Reddit, which conveys that the firm has a growing business. However, while considering the company's aspects, an analysis of Reddit's stock price is required to conclude whether its recent surge is warranted.
As a growth stock, Reddit's price-to-sales ratio speaks volumes, especially as the company is focused on scale instead of efficiency. Moreover, the enterprise value-to-sales ratio is critical to analyze, as it provides an idea of the stock's relative value.
Reddit's forward price-to-sales ratio of 9.37x is 6.43x higher than its sector median, while its forward Enterprise Value-to-EBITDA ratio of 82.15x is at a 9.77x premium. Although Reddit is growing rapidly, its price multiples suggest it is relatively overvalued at this stage, which raises a red flag.
Furthermore, a look at the technicals shows that Reddit's stock has a Put/Call ratio of 0.91, a short float % of 13.16%, and a relative strength index of around 65. Although these numbers aren't too alarming, they suggest Reddit is nearing overbought territory.
Wall Street's Take – Pre Meme Crowd Entry
As might have been expected, Reddit's first public quarterly earnings release resulted in numerous opinions from Wall Street analysts. These opinions were formed prior to Reddit's meme stock-driven surge, but they occurred nonetheless.
Bank of America (BAC) reiterated its neutral rating and price target of $57 per share. Although Bank of America acknowledged Reddit's robust user growth and new initiatives, it remained coy.
Meanwhile, Morgan Stanley (MS) upgraded its price target to $63 from a previous $45 on the basis of Reddit's meaningful first-quarter results, which surpassed the bank's estimates.
Other Wall Street analysts might voice their opinions in the following weeks. However, the prevailing sentiment suggests that Wall Street believes Reddit's post-IPO surge is warranted.
Final Word
Our analysis of Reddit's trading history and the influencing factors suggests that the possibility of irrational trading is high. However, analysis of the company's fundamentals argues that fair value determination is difficult. Therefore, despite the impact of meme stock investors, volatile trading isn't a surprise.
Despite the company's comprehensive user growth, we think Reddit's stock is a hold. The company's uncertain pathway to accounting profitability, potential data licensing headwinds, a competitive advertising market, and its elevated valuation multiples stir the pot.
We will revise the stock when material circ*mstances have changed.
Consensus: Hold/Market Neutral
Pearl Gray Equity and Research
Pearl Gray Equity and Research is a Proprietary Investment Fund and Market Research Firm that emphasizes systematic risk analysis and bottom-up exploration. Our coverage includes developed market stocks, emerging market stocks, ETFs, fixed-income vehicles, and REITs.A noteworthy consideration: Excess returns derive from systematic risk + company-specific risk + skill + luck. Don't underestimate the importance of luck. With that said, happy investing, everyone!Aside: Kindly note that our posts don't serve as financial advice.
Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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