Cathie Wood Just Bought Reddit. Is She Right?

Cathie Wood, head of ARK Invest, was among the first prominent investors to buy the Reddit (NYSE:RDDT) IPO when the company went public in March.

ARK Invest bought just under 10,000 shares of the company, adding small positions to both its Next Generation Internet and Fintech Innovation ETFs.

Is Cathie Wood Right about Reddit, or will the social media company prove to be a losing play for ARK?

Reddit Is Beating Expectations

The biggest upside for Reddit shareholders is the fact that Reddit significantly outperformed expectations in its first-ever earnings report. The consensus estimate for the company’s revenue was $214 million. In Q1, the company managed to deliver $243 million of revenue.

Even more impressive was the rate of revenue growth, which reached 48% compared to the year-ago period.

Reddit still suffered substantial losses for the quarter, though even these were better than analysts had initially expected. The company posted a net loss of $575.1 million or $8.19 per share. This, management explained, was in large part attributable to IPO-related expenses.

Analysts had expected the company to lose around $8.45 per share, making even the Q1 loss a solid beat.

Another positive that stood out in the Q1 report was the growth in daily active unique users. This number grew 37% year-over-year to a total of 82.7 million. GAAP gross margin reached 88.6%, compared to 83.6% last year. By several key metrics, Reddit’s Q1 performance was unexpectedly strong.

But the Value Is Still Questionable

Though the company’s performance has been better than expected, the stock’s pricing may not be low enough to appeal to value investors.

Critically, Reddit has been in business for nearly 20 years and still hasn’t managed to become profitable. For reference, Facebook (now Meta) launched in 2004 and was profitable by 2009. As such, investors may be somewhat wary about buying into the company.

If the stock was priced at a level that reflected these concerns, Reddit may well be a more intriguing purchase but its share price of $34 per share at the time of its IPO already raised valuation concerns.

With RDDT share price now trading at nearly $60, investors run the risk of paying too much for a company whose positive earnings could still be multiple years out.

This valuation problem became especially pronounced when Reddit announced a partnership with OpenAI. The announcement, made shortly after the first earnings release had already sent shares higher, catalyzed a further advance of another 16%.

Under the partnership, Reddit will receive AI features while OpenAI will get free access to Reddit’s enormous troves of data. Though the partnership has benefits for both companies, it’s not yet clear whether access to OpenAI’s tools will really help to drive revenue growth or if RDDT is simply running up on the latest round of AI hype.

Precisely honing in on a valuation is reflected in analysts’ target prices. Even factoring in target hikes after the earnings report, the average price forecast for RDDT is $58.93, about 1.5% below the most recent trading price.

Why Did Cathie Wood Buy Reddit Stock?

Cathie Wood bought Reddit stock because of the growth potential stemming from 430 million monthly users and treasure trove of data useful to AI companies. 

The tendency to overestimate valuations has been a major stumbling block for Cathie Wood’s disruptive technology strategy.

One of the most notable examples was ARK’s projection that Tesla shares would reach $1,400 this year, nearly eight times the price they actually trade at.

Overly optimistic valuation assumptions have led Wood to buy growth stocks at overly high prices and contributed to lackluster performance at ARK.

Over the last five years, the main ARKK Innovation fund has returned an average of just 2.0% annually.

On Reddit, Wood is already sitting on substantial gains due to the effects of a positive Q1 report and the OpenAI partnership. As such, it’s very difficult to argue that taking a small position in the Reddit IPO was anything but a good investment decision.

Provided Reddit can maintain its current level of performance, there seems to be little near-term risk that the stock will sink back toward the price it debuted at.

Is Reddit a Buy Now?

The outlook for investors who pay today’s prices, though, may not be so positive. As noted earlier, the extensive long period over which Reddit has been losing money is a key concern.

Even though the company is free of long-term debt and maintains a cash reserve of about $968.5 million, it will eventually have to make substantial moves toward profitability to sustain its high prices.

Weighing in against these concerns on the positive side is the fact that Reddit is a massively popular platform that has strong potential for continued revenue growth.

The company’s global user base is estimated at 1.2 billion, and about one-third of US adults between the ages of 18 and 29 use the site. If Reddit can continue driving advertising sales higher, it’s fairly clear that the site has the opportunity to become a positive cash flow generator.

The bull case for Reddit is clearly bolstered by its Q1 results. However, management doesn’t see another beat of that caliber. Revenue for Q2 is expected to be between $240 million and $255 million, suggesting that revenue growth is likely to level off somewhat for the remainder of the year.

There is plenty to like about Reddit, but the stock is also priced at a level that leaves virtually no room for execution risk. With shares having basically doubled since the IPO and little headroom left for upward movement, RDDT doesn’t look like a particularly good buy at the moment.

Cathie Wood appears to have been right to invest in Reddit, but the price she paid for the stock was substantially more attractive than what investors can get today.

Furthermore, the block of RDDT shares she bought was tiny in comparison to the major holdings in her portfolio. So, while her call on Reddit was very likely the right one, ARK’s investors may not see much benefit.

At today’s prices, other investors could have a hard time finding value in RDDT, even though the company’s performance has been quite impressive.

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