- Reddit shares in demand
- The company is seen as a way of playing the hot AI trend
- It has big plans to grow user numbers, increase engagement and boost advertising income
Dan Coatsworth, investment analyst at AJ Bell, comments:
“Reddit’s successful IPO represents a return to pre-pandemic days when investors were happy to lap up shares in loss-making companies if they offered a compelling narrative. Having priced the IPO at the top end of the marketing range, Reddit’s shares have subsequently jumped as trading gets underway.
“This will turn a few heads given the social media platform’s previous association with the stock market and might prompt people to look closer at what the fuss is all about.
“Many people associate Reddit with the pandemic’s meme stock craze where an army of retail investors rushed to the social media platform to discuss targets with the intention of working collectively to drive up prices. The Wall Street Bets forum on Reddit became a breeding ground for stocks like Game Stop and made headline news around the world and was even depicted in the Hollywood film ‘Dumb Money’.
“While that was a short-lived fad, partially because most of the target companies were low quality and not necessarily good investments, Reddit as a social media platform has continued to grow in popularity. A vibrant user base engaged in all manner of topics creates an opportunity for Reddit to make money from selling data based on the rich user-generated content and from advertising.
“Why have its shares been a hit at IPO? A key reason is the link to artificial intelligence, a current hot investment theme. Reddit is seen as one of the engines that will feed AI models.
“Consumers are talking about all kinds of topics, themes and products, offering advice and sharing their experience and knowledge. This information is incredibly valuable and Reddit has begun to licence this content to third parties. Whether users are comfortable that Reddit is making money off their contributions is another thing – it presents a risk that people stop using the social media network in the long term.
“Investors have a ferocious appetite to buy shares in anything linked to AI, as evident by the storming share price performance of names like Nvidia and Meta Platforms over the past year or so. Nvidia’s sales have soared thanks to demand for its chips that power AI. Meta has shown the benefits of using AI to serve up videos that keep users engaged and exposed to more third-party promotions, thus raking in more advertising dollars. That’s led investors to speculate Reddit could also get a slice of the AI pie.
“Reddit is now using AI to improve the user experience by recommending relevant posts and communities. It’s clearly looked at the success Meta has enjoyed with AI and how that’s made users stickier and sessions last longer. It’s the old trick of giving people something they didn’t know they wanted, but ultimately engage with. Meta has also leaned more on video clips to keep its users hooked and Reddit is going down the same path.
“The popularity of the platform means that Reddit has the opportunity to grow its advertising income. Its hive of niche forums means that companies can run very targeted promotions, reaching exactly the type of person interested in their products and services. That’s music to their ears.
“Theoretically, Reddit could charge more for its targeted advertising opportunity than a company would pay to run a blanket promotion on a website. This provides another growth lever.
“What’s interesting about Reddit is that it has a long list of ideas to improve the user experience and grow earnings. That’s another reason why investors have been drawn to the stock. There is an opportunity to increase awareness of the brand and grow user numbers. It’s a classic network effect – the more people using it, the more useful it will be.
“While this all sounds very exciting, a successful investment still boils down to paying the right price. The IPO valued Reddit at $6.4 billion which is roughly eight times 2023’s sales and certainly not an excessive valuation.
“By comparison, Meta trades on 9.5 times last year’s revenue. Some might argue the difference in valuation is too narrow given Meta is a highly profitable business and Reddit is not. Others might say that it is Meta that’s too cheap and not Reddit being too expensive. This difference in opinion is what makes a market.
“Reddit has fast revenue growth and very chunky gross margins, both a big tick in the box for investors. But it is losing money. That needs to change and is something which prospective investors need to consider hard if they are interested in the shares.”