Reddit's (RDDT) short-term pains may lead to long-term gains, in my view. The leading social media platform lost more than 25% of its market value soon after it reported Q3 earnings on October 30 . This crash followed traffic headwinds from Google's (GOOGL) AI Overviews and the rollout of its new artificial intelligence (AI) Mode features, which negatively impacted Reddit's user growth.
However, on November 4, Reddit stock surged 6% after the company announced that it is testing ad placements on Reddit search pages. This is a major step forward in monetizing its existing user base. The company is also planning to double down on forcing non-logged-in users to create accounts and log in to the platform. I am bullish on Reddit as I believe its recently announced strategies will trigger strong earnings growth.
Reddit Is Under Threat from AI
Although I am bullish on Reddit long term, there's no denying the company faces a major challenge as search engines embrace AI answers. The biggest culprit is Google. The aggressive rollout of AI Overview and AI Mode have fundamentally changed SEO principles. As confirmed by Reddit's management, Google continues to crawl Reddit to support AI answers. However, this does not translate into any user growth for Reddit.
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Commenting on this during the Q3 earnings call, CEO Steven Huffman said, "Google is crawling us as hard as ever. So the demand hasn't changed from their point of view either. The reality is: the AI Mode does not drive traffic, not for us and not to anybody as far as I know. So it's just a fundamental shift in how Google works. It used to be a traffic driver. Now it's not. So now that changes the equation for sure."
Google search referrals have historically played a big role in Reddit's user growth. The company's user acquisition funnel usually begins with a Google query, which leads to a Reddit click, which results in a non-logged-in user acquisition. Over time, Reddit converts these users into logged-in users through its appeal. This business model is now under pressure, as AI Overview and AI Mode threaten the company's user-acquisition funnel.
Reddit Is Doubling Down on Monetization
One of the reasons behind my bullish stance on Reddit despite the threat posed by AI is the company's focus on improving monetization of its active users. The company is trying to achieve this objective in two ways. First, as CEO Huffman revealed on the Q3 earnings call, Reddit is gradually transitioning to a fully logged-in-only experience. The company is initially testing this in select markets outside the United States.
The core objective of this initiative is to encourage logged-out Reddit users to create Reddit accounts and sign in to the platform. Converting its massive anonymous user base into a trackable, engaged audience should boost its monetization potential. According to company filings, Reddit served 130.3 million daily active unique users in Q3 , with 76.8 million, almost 59% of total active users, using the platform without logging in. On the earnings call, Reddit confirmed that almost 80% of revenue comes from logged-in and app users (only 41% of total active users), highlighting a significant unrealized revenue opportunity.
Second, Reddit is testing direct ad placements on search pages, which is likely to improve monetization further in the long run. Reddit threads are used by high-intent users. Ads shown right within the search pages are more likely to be relevant to active users and get attention than ads in a more passive feed. If executed correctly, this strategy could help Reddit offset the negative impact of weak user growth in the foreseeable future.
AI Is Creating New Opportunities for Reddit
My bullish stance on Reddit is supported by the company's potential to benefit from AI through content licensing agreements. Although AI search results are hurting user growth, Reddit is well positioned to monetize its massive library of user-generated questions and answers. One classic example is the company's licensing deal with Google for $60 million per annum . This partnership gives Google real-time access to Reddit's Data Application Programming Interface (API), allowing Google to utilize Reddit's over 1 billion posts and 16 billion comments to train its Gemini models.
In addition to Google, OpenAI has also struck a partnership with Reddit to access its content.
Reddit's Valuation Leaves Margin for Error
My bullish stance on Reddit is strengthened by the company's cheap valuation. Reddit is currently valued at a forward P/E multiple of 12.16x . For comparison, social media giant Meta Platforms, Inc. (META) trades at a forward P/E multiple of 20.24x . Although Meta certainly deserves to trade at a premium to its peers given its unmatched scale and proven monetization expertise, I believe Reddit is too cheaply valued at a time when the company is beginning to double down on monetization.
In the short term, Reddit's strategy of aggressively converting logged-out users into logged-in users is likely to create friction. This strategy may even lead to a short-term decline in active users. However, in the long term, Reddit is likely to end up with a higher monetizable user base. When this happens, Reddit's valuation is likely to benefit, as the market will see its user base as higher-quality and authenticated, commanding premium targeted ad rates.
Is Reddit a Buy, According to Wall Street Analysts?
Based on the ratings of 24 Wall Street analysts, the average Reddit price target is $159.81 , which implies upside of 70% from the current market price.
Takeaway
Reddit stock crashed following the Q3 earnings report, but gained momentum on November 4 after the company announced the rollout of ad placements in search pages. This marks a new initiative by the company to aggressively monetize its user base. Although Google's AI search strategy threatens the company, I believe Reddit's valuation is cheap enough to bet on it as monetization gains pace. Although short-term user growth may be disappointing, I believe Reddit is well-positioned to report strong earnings growth in the coming years. This should pave the way for a valuation re-rating.
