How to know if Snaphat stock is a buy or a sell

Since its March debut, shares of SNAP have traded over a wide range. Nobody, it seems, can agree on how much the stock is worth.

Henry Blodget, Business Insider’s Editor in Chief, says nobody knows the future. However, as he explains, there is a fundamental framework for investors to use to assess any company’s value.

Following is a transcript of the video.

How much is the hot new IPO SNAP worth? The market doesn’t seem to know. Is it the $US28 high, or the $US19 low, or is it as low as $US10, as some analysts say it should be? Snapchat is clearly an explosive global phenomenon, but a hot company does not necessarily make a hot investment. So, let ‘s start with what we know.

Stocks are a claim on future earnings. Almost all stocks eventually trade for about 10 to 20 times earnings. When Google and Facebook went public, for example, their stocks traded at seemingly crazy multiples for a while. But then the companies’ earnings grew extraordinarily fast. Now, many years later, the stocks trade for about 20 times this year’s projected earnings.

Someday, even Snapchat is likely to trade at about 20 times earnings, too. So let’s think about how much money the company has to earn to support the current valuation and provide a compelling return from here.

At $US24, SNAP is valued at about $US30 billion. To trade for 20 times earnings Snapchat would need to earn about $US1.5 billion a year. That’s certainly not going to happen this year or next year. But bullish investors believe that Snapchat can ultimately generate $US10 billion of revenue in five years.

Assuming low content costs and a high profit margin, that could mean $US3 billion of earnings after tax.

If so, and if Snapchat trades for 20-times earnings, it could be worth $US60 billion in five years, about twice what it’s valued at today.

If that happens, an investor who buys Snapchat today might earn a return of about 15% per year going forward. Of course, Snapchat might not earn $US3 billion in 5 years. In fact, given its current rate of losses, it might never earn anything. If that happens, Snapchat could ultimately be worthless.

This wide range of potential future outcomes is what is causing Snapchat’s wild volatility today.

Don’t go searching for the analyst who knows what Snapchat is worth, because they don’t exist. Nobody knows what the future is.

But we do know that Snapchat is likely to ultimately trade at 10 to 20 times earnings. So to buy Snapchat at $US25, you should decide whether you think the company can earn at least $US3 billion in 5 years. If it can, then Snapchat might even be a “buy.”

If it can’t, then it’s probably a “sell.”

Get the latest Snap stock price here.

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