Up Over 30% Since IPO, Is Reddit Stock (NYSE:RDDT) Overvalued?

The social media platform Reddit’s (NYSE:RDDT) IPO is still fresh and has been well-received by investors so far. Its first two and a half months of trading as a public company have shown strong share price appreciation (up over 30%). The company has made good progress in key metrics amid promising growth trends. While there are significant execution risks associated with its growth strategy, I believe the company is well-positioned, and its premium valuation may be justified. Therefore, I hold a cautiously bullish position on RDDT.

In this article, I’ll outline the reasons behind my stance, starting with the company’s monetization capacity, ongoing initiatives for revenue diversification, latest developments, and valuation.

The Challenge of Monetization Growth Facing Reddit

Reddit is currently one of the most visited websites globally. Recent surveys indicate that the company’s website ranks seventh in global traffic, while U.S. data from the end of last year places it third, trailing only Alphabet’s (NASDAQ:GOOGL) Google and YouTube. However, despite its impressive traffic figures, Reddit may not have optimized its user monetization strategies to the fullest extent, although it has made significant progress in this area.

In the most recent quarter, Reddit reported 82.7 million “daily active uniques” (DAUq) out of the approximately 850 million users who use the platform once a month. The platform generated $243 million in revenue, nearly entirely from ads, representing a 48% annual increase. This indicates that Reddit is generating $2.94 in revenue per daily active unique per quarter. These monetization metrics surpass those of Snap (NYSE:SNAP), which in Q1 2024 was $2.83, and Pinterest (NYSE:PINS), which in Q1 2024 was $1.46.

The major challenge for Reddit is to ensure that its monetization continues to grow and align with the increased retention of active users on the platform, considering its unique characteristics. Reddit is essence-driven and community-centric, allowing users to interact anonymously. This aspect often leads to the creation of authentic and relevant content, thereby attracting more users and, consequently, revenue.

A crucial aspect of the platform’s essence lies in the profile of its users and the content they share. While not intending to generalize, Reddit users often perceive the platform as an escape from a more curated online world. For example, Meta’s (NASDAQ:META) platforms like Facebook and Instagram, which are the poster children for success in ad monetization, often see users sharing their most photogenic moments rather than their most authentic selves.

However, this audience demonstrates higher engagement with ads and tends to click and buy more frequently. Conversely, many posts on Reddit are labeled “not safe for work,” indicating higher barriers for advertisers seeking to promote their products on the platform.

Furthermore, Reddit’s platform is not necessarily advertiser-friendly, and communities have a cultural aversion to ads. This makes it much more challenging for a Reddit user to make a purchase through an ad on the platform compared to Instagram, for example.

The platform must show shareholders that besides ads, there are alternative ways of monetization. Nevertheless, these steps are still in their early stages.

What Measures Has Reddit Taken to Enhance Monetization?

Given that nearly all of the company’s revenue stems from ads, there are new projects in the pipeline that demand heavy investment to improve ad monetization and explore alternative revenue streams. The latest Q1 earnings data reveals that $437 million was spent on research and development (R&D), nearly double the revenue generated in the period.

Reddit has also presented a future monetization plan for the platform, consisting of a multi-chapter growth strategy that aims to transition from solely focusing on ads to incorporating data licensing. Under this plan, customers can pay to access real-time data streams of anonymous, public discussions on Reddit via data APIs (application programming interfaces).

The company has entered into a $60 million per year deal with Google to provide access to its content for training Google’s AI language models. This partnership is intended to enable Google to utilize Reddit’s data to enhance its services, including Google Search. While the deal may seem modest at present, its potential impact could be significant in the AI space as it scales up.

Other monetization sources will include a platform for developers, membership programs, and a community marketplace that enables the buying and selling of digital and physical goods.

According to the company’s management, significant advancements in the emerging data licensing business occurred in Q1, contributing to a remarkable 450% year-over-year increase in non-ad revenue.

Regarding ad revenue, which totaled $223 million in the quarter, there was a substantial year-over-year increase of 39%, marking the third consecutive quarter of accelerated growth. Management attributed this growth to Reddit’s market funnel strategy and its commitment to providing advertisers with unique opportunities on the platform. Building on this success, Reddit launched “free-formats,” offering advertisers a versatile and creative format to enhance user engagement and drive higher click-through rates.

Is Reddit Worth a $10 Billion Valuation?

As stated earlier, since its IPO at the end of March, Reddit has appreciated by over 30%, now trading near $62. The company boasts a market cap of over $10 billion and trades at a price-to-sales (P/S) ratio of 11x, well above peers like Snap and Pinterest, which trade at multiples of 5x and 8x, respectively.

This appears to be a high multiple, but it is justified by Reddit’s robust revenue growth over the last three years. Reddit has achieved a compound annual growth rate (CAGR) of 52%, more than double that of Snap over the same period.

It’s worth noting that Reddit is still in the early stages of capitalizing on user growth and exploring new product avenues to diversify its revenues. The company looks set to benefit in the future from secular growth trends in digital advertising, AI, and the creator economy. This has been the focal point of Wall Street’s investment perspective on Reddit.

Is RDDT Stock a Buy, According to Analysts?

The consensus among analysts rates Reddit stock as a Moderate Buy, with nine out of 16 recommending buying the stock at current levels. The average RDDT stock price target is $58.93 per share, indicating 7.1% downside potential.

Needham analyst Laura Martin is bullish on Reddit stock. She cites the company’s strong corporate culture and commitment to community building as foundational to its mission, serving as unique selling points that distinguish it from competitors. Additionally, Reddit’s significant user and revenue growth during the first quarter of 2024 underscores the effectiveness of its user acquisition and retention strategies.

On the other hand, Goldman Sachs (NYSE:GS) analyst Eric Sheridan, who has a neutral recommendation on Reddit’s stock, is skeptical regarding Reddit’s ability to sustain growth in advertiser count and ad budget. He is particularly concerned about effectively balancing these drivers amid major brand advertising recovery execution risks and short-term uncertainties.

The Bottom Line

Reddit appears to be strongly positioned to further enhance monetization, as its recent results indicate. The company is heavily investing in alternative revenue streams beyond relying solely on ads. I particularly support initiatives such as partnering with large tech companies for data licensing to train AI models, which align with the platform’s essence and could serve as a valuable source of future diversification.

However, the major challenge is that this transition is still in its early stages and carries a high execution risk. Because I view Reddit as still being in a “show-me” phase, I believe that adopting an overly bullish stance at this time could be premature, especially considering that the company’s IPO is relatively recent. Nonetheless, I believe that the company’s valuation multiples may be justified, given its growth potential. Therefore, I am adopting a cautiously bullish stance on the stock.

Disclosure