Advertising Revenue

Snap Inc. (tkr: SNAP), the parent company of social media company Snapchat, recently went public in the largest US IPO since 2014. Snapchat relies on revenue from advertisers who are looking to reach the younger millennial generation. Alongside this IPO, we wanted to take a look at the broader advertising revenue market to get an idea of growth trends in the space.

According to eMarketer, total media ad spending worldwide is expected to be about $575 billion in 2017, with an average annual growth rate of just over 5%. Digital media offers advertisers a way to reach a more granular audience compared to traditional media forms, such as television and print advertising. Not surprisingly, digital media’s share of ad spending is growing rapidly and taking share from other traditional media ad channels. In fact, eMarketer estimates that digital media ad spending will overtake TV ad spending this year. The rapid rise in digital advertising has helped deliver impressive revenue gains for digital companies like Facebook (tkr: FB) and Alphabet (tkr: GOOG). Furthermore, digital ad growth has fueled the hype behind newer companies such as Snap, which some believe could see a boost as advertisers look to attract the coveted millennial user base. Alongside this growth, the combined market cap of digital advertising companies has grown to over $1 trillion. This is roughly 4.5 times the $220 billion digital advertising revenue opportunity. By comparison, the combined market cap of publicly-traded print advertising companies is about $15 billion, which represents just one-fifth of the $74 billion print advertising revenue opportunity. Of course, we would expect higher valuations for the digital advertising companies due to its higher growth expectations, but we cannot expect that this rapid growth will be endless.

At some point, digital media ad spending growth will likely moderate to around the 5% average total media growth rate, if we believe in the law of large numbers. We could also see a new advertising medium introduced, which could overtake digital advertising. In any case, we believe it is unlikely that digital advertising revenue will accelerate growth from current levels. While we certainly want to be invested in this fast-growing space, we also remain mindful of company valuations when choosing how to invest. We made the decision to invest in Alphabet, which is currently trading at 30 times earnings and about 6.5 times sales. We think this is a more reasonable valuation compared to Facebook, which is trading at 40 times earnings and 15 times sales. Snap Inc. is not yet profitable (Snap lost $515 million in 2016) so we do not have a price-to-earnings ratio, but Snap is trading at over 63 times sales. Furthermore, we like that Alphabet has been investing to diversify their revenue beyond the advertising market, namely with the “Other Bets” segment. This segment includes emerging technologies such as self-driving cars, artificial intelligence, and the Internet of Things, all of which could open up new streams of revenue for the company.