Earlier this year, social media platform and information forum Reddit(NYSE: RDDT) completed an initial public offering (IPO). Like many newly minted public companies, Reddit stock experienced an initial price pop but quickly cratered as some investors grew skeptical of the company's growth prospects. In particular, Reddit was making a case for having ties to artificial intelligence (AI), but it wasn't convincing stock buyers. The company touted how its user data could be leveraged to help big tech companies train information workloads and large language models (LLMs).
This idea seemed more reasonable in theory than in reality and I had some doubts as to whether Reddit could execute on this particular business segment. But following the company's recently published third-quarter earnings report, I'm changing my tune.
Let's look at how Reddit is entering a new and exciting growth phase and assess if now is a good opportunity to scoop up shares.
How Reddit proved me wrong
Just after Reddit's mid-March 2024 IPO, I expressed some serious doubts over the company's ability to grow its core advertising business and make anything of its AI pursuits. At the time, Reddit's value proposition was a tough sell considering far larger competitors such as Meta Platforms and Alphabet dominate the internet.
However, Reddit's third-quarter earnings showed some surprisingly good metrics. Revenue grew by an impressive 68% year over year to $348.4 million. Even better, the young company's free cash flow and net income were both positive figures. During the third quarter of 2023, Reddit was hemorrhaging cash.
How did Reddit manage to spearhead this level of revenue acceleration while also generating positive unit economics in such a short time? Two levers work in the company's favor right now.
First, Reddit's daily active uniques (a proxy for active users) rose 47% year over year to 97.2 million. Generally speaking, more users result in higher engagement on social platforms. When this happens, advertisers want to broaden who sees their ads, allowing Reddit to monetize its user base more effectively.
What's even better is that Reddit's average revenue per user (ARPU) is growing by similar percentages in both the U.S. and abroad. To me, this suggests that advertisers are onboarding to Reddit's platform at global scale -- implying the company has growing brand appeal in many different geographic regions.
In addition to its advertising revenue growing by 56% year over year, sales from data licensing rose by a whopping 547%. In simple terms, I was wrong about Reddit's AI plan. Here's why.
Image source: Getty Images.
What could AI mean for Reddit in the long run?
Even though Reddit's data licensing revenue grew fivefold year over year, sales from this segment were just $33.2 million during the third quarter. Moreover, for the nine-month period ended Sept. 30, data licensing revenue totals $81.6 million -- or just 9% of Reddit's total revenue.
While data licensing remains somewhat small for Reddit, I see this opportunity in a whole new light now. Check out the table below of Reddit's remaining performance obligations (RPO) for data licensing agreements.
| Category | January 2024 | Q1 2024 | Q2 2024 | Q3 2024 |
|---|---|---|---|---|
| Data Licensing RPO | $203.0 million | $188.1 million | $320.3 million | $294.8 million |
Data source: Reddit.
In less than a year, Reddit has grown its data licensing deals by tens of millions of dollars. Moreover, given these are multiyear deals, the company will recognize these sales over time -- thereby providing some level of predictable growth for this new AI endeavor.
To me, the AI opportunity for Reddit is very much real and the RPO trends shown above underscore this idea. While data licensing is already a business worth hundreds of millions of dollars, Reddit has a lucrative opportunity to expand this operation in a meaningful way as data becomes even more critical for training LLMs and generative AI protocols.
Is Reddit stock a buy right now?
I took a shot at benchmarking Reddit against other social media and data-heavy businesses using the forward price-to-earnings (P/E) multiple.
RDDT PE Ratio (Forward) data by YCharts
There are some pretty interesting takeaways from the trends pictured above. First, both Meta and Alphabet trade at significantly lower multiples compared to Reddit and Spotify Technology. One reason for this could be that Meta and Alphabet are competing in much more crowded spaces revolving around AI -- from social media to virtual reality, cloud computing, workplace productivity, gaming, and more.
Additionally, it's quite obvious that both Reddit and Spotify have been experiencing some valuation expansion in recent periods. For Spotify, I think much of the momentum is rooted in the idea that streaming platforms will become a more important megaphone and distribution channel for a variety of opportunities in the future.
As an example, podcasting platforms were a go-to for both presidential campaigns this year. I suspect Spotify and competing platforms will experience additional tailwinds as streaming becomes a more widely adopted form of communication alongside traditional broadcasting.
Regarding Reddit, it's pretty clear the company's valuation soared following its blowout third-quarter report. While Reddit stock is pretty pricey as a result, I would not discount the company's growth potential. To me, Reddit is still an overlooked opportunity at the intersection of data and AI -- making it a tempting buy at a more reasonable price range.
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. Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Adam Spatacco has positions in Alphabet and Meta Platforms. The Motley Fool has positions in and recommends Alphabet, Meta Platforms, and Spotify Technology. The Motley Fool has a disclosure policy.
