Preferred Tech IPO Investment Option for June
IPOs draw a significant amount of attention on Wall Street and among retail investors, but generally, they're better left untouched.
While IPO shares frequently surge on their debut days, particularly for high-profile ones, over the long haul, the majority of IPOs underperform the market. Based on one study, around two-thirds of IPOs are performing below par three years after their listing, using the S&P 500 as a benchmark for large companies and the Russell 2000 for small ones, and most are over 10% behind the market's returns.
This isn't unexpected. Newly listed companies are battling established ones, and a significant number of them are operating at a loss and are yet to prove themselves.
However, disregard this data point at your own risk when it comes to IPO investments. After all, virtually every successful stock had its beginnings as an IPO, and early investors have typically benefited from higher returns than others. In essence, IPO shares offer the prospect of exponential returns, which is seldom seen in blue-chip stocks.
Currently, one IPO appears to be bucking the historical trend against new issues. That's Reddit (RDDT 4.27%), the social media platform that made its debut in March.
Reddit's competitive strengths
Reddit was established in 2005 and, for a long time, was somewhat of a countercultural social media network. Users interact anonymously, and the platform has not been as heavily monetized as those of tech giants like Meta Platforms (which includes Instagram and Facebook).
Reddit gained prominence during the GameStop short squeeze in 2021, introducing numerous individuals to its platform's power.
At the time of its IPO, Reddit had never turned a profit, and its growth had been relatively modest for a tech stock. In 2023, its revenue surged by 21% to $804 million. Since going public, Reddit has bigger ambitions and is focused on monetizing its user base through advertising.
Reddit stands out due to its unique social media platform, which has over 100,000 "subreddits," these being individual communities that generate unique discussions and comment threads, building a vast archive of content. It also boasts an engaged and loyal user base that increased by 37% in Q1 to 82.7 million daily active unique users (DAUs).
Reddit's content spans thousands of different subjects, giving it unique revenue streams. The company is collaborating with AI platforms that are using its content to train their large language models. For instance, in May, Reddit announced a partnership with OpenAI to bring ChatGPT content to its platform and develop new products, leveraging OpenAI's technology for new AI-powered features.
Reddit's content is also featured on Google Search's new AI summary, demonstrating the value of its extensive database in this era of technology.
Reddit is transforming
Thanks to advertising growth and its emerging data-licensing business, Reddit reported accelerating revenue growth of 48% to $243 million in Q1. It reported its first-quarter adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) profit of $10 million, representing a substantial improvement from a loss of $50.2 million in the previous year's same quarter.
The company reported free cash flow of $29.2 million, and its gross margin rose by 500 basis points to 88.6%. This signifies that the website's direct operating costs are minimal, implying that Reddit could be even more profitable if it managed to decrease overhead costs such as research and development and sales and marketing expenses.
Reddit is in the process of changing dramatically, as revenue growth accelerates and profitability expands. The stock is up almost 50% from its IPO price, but could have more room to grow if the company maintains its current pace.
If you're seeking a unique way to profit from the AI boom, Reddit could be a potential big winner if its partnerships with OpenAI and Google parent Alphabet prove fruitful.
Investing in Reddit's IPO could potentially offer higher returns than traditional blue-chip stocks due to its exponential growth potential. Despite never turning a profit before its IPO and having modest growth for a tech stock, Reddit's revenue surged significantly in 2023, and it's currently focused on monetizing its user base through advertising.
When it comes to financing Reddit's growth, the company has unique revenue streams, such as collaborations with AI platforms and featuring its content on Google Search's AI summary. The success of these partnerships could significantly contribute to Reddit's future financial performance, making it an attractive option for investors interested in the AI boom.
