Big partnerships can pave the way to top-line growth.
On March 21, user-generated content platform Reddit (RDDT 1.03%) held its initial public offering (IPO). Priced at $34 per share, the company started off with a market value of more than $6 billion, making it the largest IPO for any social media stock.
As evidenced by the stock’s 60% rise from its IPO price, investors clearly want to get their hands on shares of Reddit. And it’s understandable: The company has multiple attractive qualities.
For example, it’s a high-growth business with a gross-profit margin of nearly 90%, and it has captured the imaginations of investors with its potential applications in artificial intelligence (AI).
However, there’s one metric I love about Reddit stock right now — perhaps more than any other. I’ll admit it sounds boring, but it’s underappreciated and could get even better with time.
Here’s what I’m looking at with Reddit
Before I give away the number, I want to quickly note an important investing subject: incentives. IPO companies want new investors to pay higher prices for their shares so they can raise more money. In a way, they’re trying to sell shares by telling a compelling story, and it’s easier to spin a good yarn when the top line is growing at a fast pace.
Therefore, there’s an easy trick many IPO companies use in the lead-up to their market debut: They spend heavily to stimulate growth, even at the expense of profits. Investors tend to favor growth over profitability for these younger businesses.
In Reddit’s case, it grew revenue at a year-over-year rate of 21% in 2023. Moreover, it’s already reported one quarter of financial results since going public. For Q1 2024, revenue was up 48% year over year.
The surprising detail for me is that Reddit’s sales and marketing expenses are completely under control. This isn’t a company spending carelessly to fuel its growth.
In 2023, sales and marketing spend only increased 2%. And last quarter, it looks like those expenses skyrocketed, but there’s a lot of stock-based compensation in relation to the IPO. Adjusting for that, sales and marketing were only up 10%.
Put simply, this line item is holding fairly steady while the top line accelerates, and it’s something I appreciate about this IPO stock.
Why it could get ever better
Now, don’t misunderstand: Reddit still spends on a lot on growth. Using the adjusted first-quarter number, the company spent $59 million on sales and marketing. That’s 24% of revenue — not a small number by a long shot.
Moreover, I’m not saying the company is some sort of cash cow because it has these expenses under control. That’s not the case. Even when adjusting the numbers for the IPO stock-based compensation expenses, Reddit’s $206 million of operating expenses last quarter ate away the bulk of its $215 million gross profit.
Therefore, Reddit is losing money and probably will for some time. But when it comes to driving platform growth, management is showing a degree of discipline that is rare among IPO stocks, and it’s something I appreciate.
The good news is it could get even better.
Reddit has had a partnership with Alphabet‘s Google, but it expanded its partnership on Feb. 22. In short, Google is getting better data from Reddit, making it easier to display up-to-date content. Then on May 16, Reddit teamed with OpenAI, providing data to its chatbot ChatGPT.
A massive amount of people already use Google and ChatGPT when looking for information. And through these strategic partnerships, these people will now get greater exposure to Reddit too. It will take time to properly assess, but it seems like a very efficient way for the social media platform to boost its visibility and gain users.
In other words, I expect Reddit’s top line to continue outpacing its sales and marketing expense, and that will go a long way toward helping the company achieve profitability.
There are other things investors should watch for this business, but this is one area where Reddit looks to be on the right track. And to me, it’s enough to earn this IPO stock a place on investors’ watch lists.
Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. Jon Quast has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Alphabet. The Motley Fool has a disclosure policy.
