Snap Inc. i.e. the parent company behind the messaging application Snapchat just went public in the early days of 2017. This was not an ordinary IPO by any means. Snapchat shares rose 44% on the very first day they were listed as there was a mad rush to buy shares on the market. This startup has had the highest tech valuation in Wall Street history. It’s beginning valuation has been higher than peers like Facebook and Google.

Investors attached a massive price tag of $29 billion on this startup! While most were happy that Wall Street indices were going higher and investors were making money, a few critics were very skeptical. The underlying notion is that Snap Inc. doesn’t deserve to have nearly as much valuation as it has been given. In this article, we will analyze the Snapchat valuation to understand whether this is indeed the beginning of a new tech bubble!

Stretched Valuations

• 15x Valuations: There is nothing much to analyze in Snapchat’s balance sheet. The contents are fairly straightforward. The company has much more in current assets than its current liabilities. Hence, it seems like it is going to be around for a while! However, the net worth of Snapchat is only close to $1.5 billion. That is not small by any means. However, when you compare the $29 billion valuation given to the startup in the market the disconnect becomes evident. The balance sheet is saying something very different from what the investor’s behavior might have you believe.

• Never Been Profitable: Another worrisome fact about Snap Inc. is that the company has never reported a profit! There has been no profit at all, before tax, after tax or operating profit! Instead, in the previous financial year, the company lost $500 million a year and generated negative cash flow. No fundamental investor would pay $29 billion to this business based on the financials. Snapchat faces a formidable challenge in the future. It will have to generate billions in profits to justify the price tag that it is already sporting.

• Fickle Target Audience: The profitability target is going to be extremely difficult given the target audience that Snap Inc. caters to. Most of Snapchat’s users are teenagers. Teenagers are not known to have high spending power! So advertisers will also not pay much to target these customers. Also, teenagers are known for being remarkably fickle. They quickly move around from one company to the other. There is no historical precedent where a company with stable cash flows and profits has been created with a teenage customer base. Snapchat. Therefore has a lot to prove.

• No Competitive Moat: Also, Snapchat does not have any competitive moat. The app differentiated itself from the others by the extra features that it provided. However, none of these features are patentable. Hence, they are not exclusive to Snapchat and can be produced by anybody. More established companies like Facebook and Instagram have been replicating the features provided by Snapchat. Snap Inc has been continuously innovating to stay ahead. However, investing in a company that has to continually run races to be successful is not very appealing to investors.

Causes

• Huge Number of Day Traders: The problem with Snap Inc stock is that there are a high number of day traders that are buying the stock. Day traders are typically inexperienced traders that conduct no fundamental analysis. They believe in the latest fad and have a get rich quick mentality. There is a saying in the stock market that when day traders enter a stock, it is time for the established investors to get out. The valuations being given to Snap Inc are therefore being given by inexperienced investors and do not represent the health of the underlying company.

• Highly Volatile: Snap Inc’s stock is increasingly volatile. The stock went up by 44% on the very first day it traded. Then it came down crashing back to where it started from. The founder of Snapchat, gained an ephemeral $2 billion which vanished in thin air as investors exerted downward pressure on the stock. Once again, this is not the making of a long-term stock. Investors prefer stocks that are relatively stable in value. Stocks with huge variations in price don’t last very long.

• Popular Vs. Profitable: Snapchat’s investors seem to be confusing popular with profitable. It is true that Snapchat brand is very well known amongst the teenagers throughout the world. However, the founders still haven’t found a way to convert popularity to cash. There is still a very long road ahead. This road could be very rocky indeed as it is full of competitors.

• Easy Money: Snapchat’s IPO has been further fuelled by the easy money monetary policy that has been going on for too long. The Fed has kept the interest rates artificially low for an extended period of time creating an excess money supply in the market. This excess supply is finding its way into overheated startups like Snapchat. This seems like the replica of the irrational exuberance that was displayed during the tech bubble in 2001, and as well all know that did not end well! Investors who have put their money in Snapchat must be prepared to either be rewarded handsomely or to lose everything.