“Cult Stocks,” an investment strategy?
This is the first publication of the Millennial Finance Times, a blog dedicated to analyzing the financial market through the Millennial’s perspective. The most exciting thing to happen this week and an obvious talking point is Snap Inc.’s IPO on Wednesday.
Snap Inc. is the parent company of the famous social media app Snapchat, used to share pictures that disappear in less than 24 hours. Everyone knows Snapchat and the potential it has, with 158 million daily active users and an average number of snaps per day of 2.5 billion, it is clear that Snapchat can become a strong cash generating app. Snap’s revenues have been growing at an astounding rate and are forecasted to continue.
As we can see in the graph, Snap Inc. is forecasted to grow daily active users at a 3.75% rate quarter to quarter. These daily active users translate into revenues, but is Snap really generating cash? The short answer is NO. Snap is the type of company that is hard to forecast, has high volatility and moves in a non-traditional way. The company is valued at $28.36B with negative earnings and no sign of turning this earnings into positive ones any time soon. When a company is not profitable, but has high potential and popularity it becomes like a cult for stock traders, making the stock less sensitive to traditional market catalysts and more unpredictable. A good example of this type of stock is Tesla. By studying Tesla, you can understand that even when a company constantly disappoints its shareholders, if it has become a “cult stock”, it still might grow. This type of growth is non-sustainable because it does not come from real cash flow growth that would increase the company’s valuation, but rather comes from high demand for the stock. A shift in demand for these types of stocks can result in disastrous falls in stock price and loss of value for shareholders.
My prediction for Snap Inc. is it will end its fiscal year below its IPO price. After a bullish period, Snap Inc. will reach a peak price and will fall abruptly, then it will stabilize towards the end of the fiscal year to close with a price of $12.95. Considering the difficulty to estimate Snap’s cash flows accurately, this valuation is rather based on a simple revenue multiple. To calculate Snap’s revenue multiple the most sensitive to do was to use Facebook and Twitter’s price/sales. It makes sense to believe Snap’s quality of revenue’s is between that of Facebook and Twitter. Now, to make the outcome more accurate you have to consider the 3 typical scenarios: Bearish, Neutral, and Bullish. On the Bearish side, Snap was weighed 60% like Twitter and 40% like Facebook. In the Neutral scenario an average does the the job. Finally, in a Bullish scenario Snap was weighed as 80% Facebook and 20% Twitter. The target price was then obtained by calculating an average of the 3 scenarios. Snap Inc. lacks some crucial information to determine the required rate of return. The industry’s rate of return on equity its a more significant Required Rate of Return for Snap in this case.
The common misconception for millennials is that stock trading should be based on whether you like the company and what it does. Millennials tend to forget about the big picture and they miss conducting a proper due diligence when analyzing a company. That is why we decided to start this publication; as an attempt to help millennials that are not familiar with finance. It is important to have a strategy when you invest in stocks. To decide what strategy is best for you, you must set a goal. Your goal can be anything like saving for retirement, learning how to trade, buying yourself a new car, having cash flows to cover expenses, or really any goal you can think of. After setting a goal you can decide the best way to invest your money, for example if your goal is to save for retirement, your strategy should focus on long-term returns and less on volatility. If your goal is having cash-flow to cover expenses, your strategy should be about dividends and short term returns.
Always remember to set goals for your investments and set a strategy to achieve these goals. Make due diligence when investing and not only invest because you like the brand. Try to look for stocks that you understand when investing. And never fall for “cult stocks”. Never follow the herd and always remember that the time to buy is when there is blood in the streets.
If you liked our article, please like and share, help us get millennials to make wise investments and get interested in the stock market. See you next week!
Disclaimer: This article is based purely in our own knowledge, experience, and research. It should not be taken as an expert’s advice for stock picking.