The S&P 500 committee added Reddit mid-quarter after a merger left the index one company short. Reddit trades 365% above its IPO price even after a post-earnings sell-off tied to slowing U.S. user growth.
The S&P 500 committee usually adds and removes constituents once a quarter, but it stepped in mid-quarter this time. AvalonBay Communities merged with Equity Residential to form Vivmark, leaving the S&P 500 one company short. The committee picked Reddit to fill the slot.
Reddit went public just a couple of years ago, but the stock now trades 365% above its IPO price.
Strong earnings, but shares still sold off
Reddit shares fell after the company's second-quarter results even though the numbers were strong. Revenue climbed 61% year over year, and adjusted EBITDA margin expanded to 42.6% from 40.1% the prior quarter and 33.4% a year earlier. The company also repurchased $235 million in shares using its growing free cash flow, and earnings per share climbed 178% from last year.
Yet investors appear hung up on a different number: daily active users in the U.S. declined sequentially. That decline is the latest sign that artificial intelligence is disrupting Reddit's business, as AI Overviews on Google may be cutting off a source of traffic for the platform in more mature markets.
Advertising still drives the business
The user trend matters because Reddit still makes most of its revenue from advertising. Other revenue, including data licensing for AI developers, made up just 5% of Reddit's total sales last quarter. Without steady growth in new users, revenue growth would eventually slow.
Reddit is positioning itself as an alternative to AI chatbots, letting users ask a community of people instead. Management believes the platform can grow to 100 million logged-in U.S. users, up from 23 million, and 1 billion globally, up from 53 million.
Even with sluggish recent user growth, the company has kept monetizing existing users. Average revenue per user climbed 36% globally and 51% in the U.S. last quarter, and continued gains in ad targeting and ad load could push revenue higher as management works to reaccelerate user growth.
Fears about AI disruption have pushed the stock's valuation to 21 times earnings expectations, a price that's attractive for a company expected to grow earnings around 25% a year, according to analysts' estimates.
Source: The Motley Fool
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