Something interesting, and bad, recently happened to Snap Inc (SNAP). The company recently filed a short warning to investors under the “Regulation FD Disclosure” (a rule that requires them to announce material changes to sales and earnings ASAP). The announcement consisted of two paragraphs; the second was boiler-plate legalese, while the first was so bad it caused the stock to plummet by over 40% in a day:
“Since we issued guidance on April 21, 2022, the macroeconomic environment has deteriorated further and faster than anticipated. As a result, we believe it is likely that we will report revenue and adjusted EBITDA below the low end of our Q2 2022 guidance range. We remain excited about the long-term opportunity to grow our business. Our community continues to grow, and we continue to see strong engagement across Snapchat, and continue to see significant opportunities to grow our average revenue per user over the long term.”
This wasn’t just bad for SNAP; after a day of recovering, the Nasdaq 100 (QQQ) and tech companies near Snap in the marketplace plummeted. While QQQ recovered a bit to end the day just down over 2% (not much these days), Facebook (FB) fell over 7%, Twitter (TWTR) fell over 5%, and even Alphabet (GOOG), one of the world’s largest companies and not really a social network, fell over 5%. What’s crazy is that Snap is the smallest of these companies; in market cap terms, it is less than a fifth the size of GOOG and less than a tenth the size of all of them combined. In terms of revenue, Snap is estimated to get less than 1% of the total market that these companies compete over.
So what happened?
By pointing to the macroeconomic environment, SNAP is finger pointing, claiming that they will report disappointing results, but it isn’t their fault. The world economy is deteriorating, so people are spending less on ads. If this is true, then they are a canary in the coal mine, and all the bigger firms will follow.
But why didn’t those other firms release similar warnings? And since SNAP’s warning doesn’t include numbers, how do we know just how much lower their sales and EBITDA are going to be? They guided for 20% year-over-year growth in sales on the low end, so how much lower will it be? 15%? 10%? Less? And why is this happening, exactly?
Answers to these questions are key. If SNAP reports, say, 19% in growth, there will be a relief swing upwards in the stock price. It’s a disappointment relative to prior guidance, but a small one. However, such small disappointments are pretty common and don’t warrant advanced announcement like this. So that is unlikely—meaning if it does happen, the relief rally will be that much stronger.
Similarly, is SNAP’s weakness endogenous or exogenous? Is this happening because, simply put, SNAP is messing up, or is happening because of all of those things that are already spooking the market—inflation, the China shutdowns, the Ukraine war, etc. etc. If it’s exogenous, the risk of stocks falling lower as earnings come out next quarter is great; if not, that risk is pretty small, and we might be near an end to the current bear market.
These are all questions that demand answers, but getting those answers is not easy. It isn’t impossible! With enough time, resources, computing power, and access to data, one could reverse engineer pretty good answers to these questions. And this could be done legally, without getting access to insider information.
At the same time, proxies can be found for the market that could, in theory, be statistically significant approximations for this kind of grand big data analysis. If, for instance, you interviewed 10 of Snapchat’s biggest advertisers and asked them how their ad spending is trending in May and if it’s getting worse (and why), you could get pretty close to an approximation of what’s really happening. But identifying, reaching out to, and understanding the answers from those advertisers is no easy task. Talking to them and analyzing their answers would not be illegal, however; this is, in fact, a crucial part of the due diligence that Wall Street does all the time.
And so enters the sell-side analyst. Following Snap’s results, sell-siders who cover the company released notes responded to the news, giving a variety of takes based on their own analysis, which is backed by their own proprietary methodologies. For instance, one large Wall Street bank released a note saying that their analyst covering Snap and its sector “believes a reduction in the advertiser/budget growth and to an extent lower willingness to experiment through an increasingly challenging macro backdrop is leading to lower bid density and pricing in SNAP’s ad auction market across all ad formats.”
In other words, this analyst believes that Snap’s pre-announcement is bad news for the sector—and the larger economy—more broadly.
Is the analyst right? We will know in due course, but the variety of analysts’ thoughts and writings on the issue offer a marketplace of ideas that investors can consult when making their own investment decisions. It is thus that sell-side analysts make a living and provide economic value: they both reflect market expectations and set them, using a variety of tools to understand the very complex and messy markets and economies investors are invested in, thus giving their clients an opportunity to make more informed decisions than your average index investor does. And for institutional investors handling very large amounts of money and complex cash flows, this kind of deep analysis can be extremely valuable.
