It’s been a volatile start to Reddit‘s (NYSE: RDDT) brief life as a publicly traded company. The network of interest-fueled community discussion boards erupted higher in its first three days of trading. It has fallen sharply in each of the three subsequent days. The stock is basically back to where it was at the close of its first day on the market.
Where will it go next?
There are some pretty good reasons to steer clear of Reddit. There’s also a pretty big reason to stick it out. Let’s go over three red flags that can keep the stock back, and the one unlikely catalyst that could make this the next hot initial public offering (IPO) to deliver generational wealth to its early investors.
Three reasons to sell
The first red flag is simply a matter of current valuation. Reddit is trading for nearly 10 times trailing revenue. Reddit and Facebook parent Meta Platforms are trading at the same top-line multiple — 9.3 times last year’s revenue — as of Monday’s close. Reddit is growing a bit faster. Revenue rose 21% last year to Meta’s 16% top-line ascent, but Meta is consistently profitable. Reddit is just starting to turn that corner. As the market leader of social media stocks, Meta deserves a market premium. Reddit still has a lot to prove.
The second challenge for Reddit is monetization. Reddit isn’t Facebook or Instagram, visual platforms ripe for marketing missives. It’s a largely text-based forum. It may not seem fair to compare it to Nextdoor, a forum with a more hyperlocal approach to being a “community of communities” hub. Nextdoor lacks the sophistication and user fandom of Reddit, but it’s another money-losing platform that figured relying on user-generated content would be a profitable goldmine. Oh, and Nextdoor is fetching a multiple of just 4 times revenue.
It also doesn’t help that volunteer moderators and high-profile users have protested monetization efforts in the past. The was even a moderator walkout last summer.
The third red flag could be Reddit’s leadership. CEO Steve Huffman is a co-founder who came back to the company he started nine years ago. There are usually warm fuzzies when a co-founder comes back to the helm, but that might not be the case here. Users and employees aren’t enamored by Huffman. Just 60% of the employees polled on Glassdoor approve of Huffman as CEO. Reddit users may be even more critical. He hasn’t posted on the site since June of last year — likely keeping a low profile ahead of the IPO — but his last few posts have all been heavily downvoted.
A big reason to buy
It may not seem possible, but the first two red flags actually combine for a strong green flag here. If Reddit can crack the code of monetizing its platform without alienating its vocal user base, its revenue would soar, its profitability could emerge, and its relative valuation to Meta wouldn’t be problematic anymore.
Meta has a much larger audience, but divide last year’s top line by its 2.11 billion daily active users and you arrive at roughly $5 a month. Work the same math on Reddit’s $804 million in revenue and the business is generating less than $1 a month for each of its 73 million active users.
The ceiling is high for Reddit. It’s a marketer’s dream, a largely young audience that isn’t typically exposed to brand marketing. Almost a third of them aren’t on Facebook. More than half of them aren’t on X. A daily logged-in user spends an average of 25 to 30 minutes engaging with the platform, and nearly two-thirds of them have a household annual income greater than $75,000. With more than 100,000 communities, an advertiser can target more effectively to reach an ideal audience. The user base will kick and scream as the ads grow and Reddit rolls out an e-commerce ecosystem, but the same thing happened to Meta and other successful platforms that critics figured could never be monetized efficiently. Criticism should fade once Reddit pushes out a contributor program to help share the wealth with its more prolific users. It’s hard to complain that a platform is selling out when its most magnetic contributors are in on the selling.
Reddit is risky and overvalued right now. The obvious transformation of the business can change everything.
Should you invest $1,000 in Reddit right now?
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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. Rick Munarriz has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Meta Platforms and Nextdoor. The Motley Fool has a disclosure policy.
3 Reasons to Sell Reddit Stock, 1 Big Reason to Buy was originally published by The Motley Fool