The social media stock is off to a strong start. Can it keep climbing?
Initial public offerings (IPOs) attract a lot of attention on Wall Street and among retail investors. But generally, they're best avoided.
While IPO stocks often pop on their opening days, especially high-profile ones, over the long term most IPOs don't do as well. According to one study, three years after they've gone public, nearly two-thirds of IPOs are underperforming the market (based on the S&P 500 for large companies and the Russell 2000 for small ones), and most are more than 10% behind the market's returns.
That makes sense: Newly public companies are competing with established ones, and many of them are unprofitable and have yet to prove themselves.
However, that data point shouldn't dissuade you from investing in IPOs entirely. After all, nearly every great stock started out as an IPO, and investors who bought shortly afterward likely have higher returns than other investors. In other words, IPO stocks offer the potential for multibagging returns in a way that blue chip stocks typically don't.
Now one recent IPO is showing signs that it could buck the historical trend against new issues. That's Reddit (RDDT 2.88%), the social media property that went public in March.
Image source: Getty Images.
Reddit's competitive advantages
Reddit was founded in 2005, and for a long time, the company was something of a countercultural social media network. Users participate anonymously, and the site has not been heavily monetized in the way that Meta Platforms properties like Instagram and Facebook have.
Reddit gained notoriety during the GameStop short squeeze in 2021, introducing many to the power of its platform.
At the time of its IPO, Reddit had never been profitable, and its growth was relatively modest for a tech stock. In 2023, its revenue grew 21% to $804 million, but Reddit has bigger plans now that it's publicly traded.
The company benefits from a unique social media platform with over 100,000 "subreddits," communities that produce their own set of discussions and comment threads, giving Reddit a massive archive of content. It also has an engaged and loyal user base that jumped 37% in the first quarter to 82.7 million daily active unique users (DAUs), and is stepping up efforts to monetize that user base through advertising.
Reddit also has a unique revenue stream thanks to its wide-ranging base of content touching on thousands of different subjects. The company is forging relationships with artificial intelligence (AI) platforms that are using its content to train their large language models. For example, earlier in May Reddit announced a partnership with OpenAI to bring ChatGPT content to its platform and new products, and Reddit will leverage OpenAI's technology for new AI-powered features.
Reddit's content has also been featured on Google Search's new AI overview, showing the value of its large database in a new era of technology.
Reddit is turning the corner
Thanks to advertising growth and its emerging data-licensing business, Reddit posted accelerating revenue growth of 48% to $243 million in the first quarter. It reported its first-quarter adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) profit at $10 million, a strong improvement from a loss of $50.2 million in the quarter a year ago.
The company also reported free cash flow of $29.2 million, and its gross margin jumped 500 basis points to 88.6%. This shows that the direct input costs to run the website are minimal, and that Reddit could be more profitable if it controlled overhead costs like research and development and sales and marketing.
Reddit is starting to look like a much different business than it has for most of its history, as revenue growth ramps up and its profitability expands. The stock is up nearly 50% from its IPO price, but could have more room to run if the company can maintain its current momentum.
If you're looking for a unique way to take advantage of the AI boom, Reddit could be a big winner if its partnerships with OpenAI and Google parent Alphabet pay off.
Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. Randi Zuckerberg, a former director of market development and spokeswoman for Facebook and sister to Meta Platforms CEO Mark Zuckerberg, is a member of The Motley Fool's board of directors. Jeremy Bowman has positions in Meta Platforms. The Motley Fool has positions in and recommends Alphabet and Meta Platforms. The Motley Fool has a disclosure policy.
