“First, investors remain hungry for stocks which offer the prospect of secular growth given the still-uncertain economic backdrop (even allowing for the bout of optimism engendered by President-Elect Trump’s infrastructure plans)
“Second, shares in more established internet and social media plays like Facebook, Alphabet, Alibaba and Tencent have done very well in the last 12 months.
“However, this does not necessarily mean Snap Inc’s deal will go ahead, reach the rumoured valuation or be a good deal for investors.
“Although revenues are reported to be rising quickly, Snap does not as yet make money. Nor do users have to pay for its service. Instead, Snap’s main source of income is selling advertisements targeted at its core youthful demographic, although the company is seeking to address this by diversifying, via the launch of its Spectacles camera product.
“This means anyone who does choose to buy the stock – if and when the deal happens – needs to tread carefully. Ultimately, it is profits and cash flow that support and drive a company’s valuation, not just the number of customers it has.
“In a worst case, the inability to generate profits or cash means a firm can’t even pay its bills.
“In a best case, it means a company is unlikely to pay the precious dividends that generate the bulk of long-term investment returns, once they are reinvested.
“A classic case in point here is Twitter. The shares floated at $26 and soared to nearly $70 but have since slumped below $20 as the firm has failed to turn over 300 million active users into anything like a profit– it lost $290 million on sales of $1.8 billion in the first nine months of its latest financial year, according to its statutory accounts.
“No-one pays to use the service and it remains to be seen if users want to see or value advertising there. If a company cannot charge for its services it has a problem and Snap will have to convince investors it can monetise its customer base if it is to sustainably command the huge valuation currently being rumoured.”