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SUMMARY
Parkev Tatevosian, CFA, discusses Reddit's recent underperformance and the significant boost following its announcement of joining the S&P 500 index. He analyzes the implications for valuation and reiterates his buy rating, citing continued undervaluation even after the stock's recent gains.
MAIN POINTS
- Reddit stock, previously down nearly 30% year-to-date, jumps 12% after news of S&P 500 inclusion.
- The inclusion in the S&P 500 is expected to bring passive index fund buyers, increasing demand for Reddit shares.
- Unlike already popular stocks, Reddit's undervaluation makes index inclusion more impactful for its share price.
- Reddit remains undervalued, trading at a forward P/E of 18.3 and below the analyst's intrinsic value estimate.
- Despite the recent rally, Reddit continues to underperform the broader S&P 500 index.
- The analyst reiterates a buy rating for Reddit, citing the positive catalyst and ongoing undervaluation.
DETAILED ANALYSIS
Reddit's stock performance in 2024 has been notably weak, with shares declining almost 30% year-to-date before a recent announcement sparked a significant reversal. The company revealed it would be added to the S&P 500 index on August 18th, replacing Avalon Bay Communities. This development led to a 12% surge in Reddit's share price, as passive index funds are now required to purchase the stock, creating a new and substantial source of demand.
The impact of index inclusion varies depending on a company's existing popularity and valuation. For stocks like Tesla or SpaceX, which are already widely held and trade at premium valuations, joining a major index tends to have a limited effect, as gains from passive buying are often offset by profit-taking from existing investors. In contrast, Reddit's relative obscurity and undervaluation amplify the positive effect of index inclusion.
Even after the price jump, Reddit trades at a forward price-to-earnings ratio of 18.3, near its historical lows, and remains below the analyst's intrinsic value estimate of $203 per share compared to the current $177. This suggests that the stock is still underappreciated by the market. The analyst has maintained a buy rating on Reddit throughout the year, last reaffirmed on July 31st, and continues to do so following the latest news.
Despite the recent rally, Reddit's stock is still down over 20% for the year, lagging the S&P 500's 10% gain. The ongoing undervaluation and the influx of passive investment are viewed as strong catalysts for future performance, leading to a reiteration of the buy recommendation rather than a call to take profits.
LINKS
- YouTube channel membership for exclusive perks and early access.
- Special offer for The Motley Fool Stock Advisor.
- Parkev Tatevosian's book on a six-step investing framework.
- Fiscal.ai investment research platform with viewer discount.
- Webull sign-up for bonus shares and commission-free investing.
- Subscribe to Parkev Tatevosian's monthly Substack newsletter.