Snap (NYSE:SNAP), the camera company that makes all its revenue from advertising, took a big tumble on Oct. 21 when it released its quarter-three earnings. Apple’s changes to the iOS platform that impact the way advertising is targeted, measured, and optimized hurt Snap’s revenue base. In short, people opted out of its ads. Since then, SNAP stock has drifted lower. But now it’s starting to look like a bargain.
As of Oct. 20, SNAP stock was at $75.65 per share, but by Oct. 22 it had dropped to $55.14. However, since then SNAP has drifted lower to $46.66 as of today.
Now it seems that SNAP stock is starting to look like an interesting value play, given the tumble. This article will look at this further.
SNAP’s Tumble and Resulting Valuation
One reason is that SNAP is now making operating and free cash flow (FCF) profits. Analysts overlooked this in the Q3 earnings release.
For example, operating cash flow was $72 million in Q3 2021, compared to a loss of $55 million in Q3 2020. More importantly, FCF became positive at $52 million in Q3 2021, compared to $70 million in the prior year.
Moreover, SNAP still projected that its Q4 revenue would be higher than Q3 revenue, albeit lower than analysts’ prior projections. For example, according to one analyst at Seeking Alpha, the company’s Q3 revenue was 3% below analyst expectations. Moreover, according to the Seeking Alpha, the Q4 guidance was well below (-13%) analysts’ expectations.
But this just explains why SNAP stock has fallen. As it stands now, SNAP stock’s valuation is starting to look interesting.
For example, these same analysts now project that earnings in two years will hit $1.35 per share at the end of 2023. That puts SNAP stock on a forward price-to-earnings (P/E) valuation metric of just 35 times. That does not seem too high for a company that will be growing revenue by over 100% by then.
Yes, that’s right. Analysts are still projecting revenue to hit $8 billion in 2023, up from $4.02 billion this year, according to Seeking Alpha. These are the same analysts that were upset that that Q3 revenue came in below their forecasts.
Assuming that the company will produce free cash flow at a high margin in two years will allow us to to forecast the stock price. Here’s how.
What to Do With SNAP Stock Now
If revenue doubles to $8 billion by 2023, even with lower iOS ad sales, it is likely that FCF will be much higher as well.
For example, using a 20% FCF margin, we can estimate that FCF will hit $1.6 billion by 2023. This makes the company very valuable.
Right now, SNAP has a market capitalization of $76.64 billion. But if we determine its future value by using the FCF yield metric — this is a rate that we can use to estimate how valuable its FCF is to the market.
For example, if we divide $1.6 billion in FCF by an FCF yield of 1.5%, the target market cap will be $106.7 billion (i.e, $1.5b/0.15=$106.7b). This means that the $106.7 billion target market value is 39% higher than its $76.6 billion market cap today.
So this also implies that even with the lower Q4 estimates, the long-term target price for SNAP stock is $66.68 per share. That is 39% higher than today’s price.
Let’s assume that it takes over one year for this price target to hit. Even if it takes two years, the average compounded return will still be 17.9% for each of the next two years. That is an excellent return on investment (ROI) for most investors. Despite SNAP’s present troubles, expect SNAP stock to be 39% higher within two years from higher free cash flow.
On the date of publication, Mark R. Hake did not hold any position (either directly or indirectly) in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.