Reddit Is Soaring. Is It Too Late to Buy the AI Stock?

Reddit (NYSE: RDDT) went public earlier this year with a unique promise in social media. Rather than just making money through advertising, the way social media companies have traditionally, Reddit aimed to unlock its massive content portal, which the company calls its corpus, and use it for training AI models.

While there was some skepticism about that business model, especially since Reddit had essentially never been profitable in its nearly 20-year history, the emergence of its advertising business and its potential in AI delivered a blowout quarter.

The stock jumped 42% on Wednesday, and shares have now more than tripled from their $34 initial public offering (IPO) price in March. Revenue jumped 68% in the quarter to $348.4 million, which smashed estimates at $312.8 million.

The advertising business remained the principal driver of growth, with ad revenue up 56% to $315.1 million. However, the emergence of the AI business was represented by 547% revenue growth in its other segment (primarily made up of data licensing) to $33.2 million.

Reddit also reported strong profit growth in the quarter and its first profit under generally accepted accounting principles (GAAP). Gross margin improved by 280 basis points to 90.1%, and adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) jumped from a loss of $6.9 million to a profit of $94.1 million, showing the company rapidly gaining leverage in its business model.

On the bottom line, it flipped a $7.4 million loss to a profit of $29.9 million, or $0.16 a share, as the company also delivered strong user growth. Daily active unique users (DAUs) rose 47% to 97.2 million, showing the platform is catching on in the AI era and as Reddit becomes a valued source of information.

User growth was broad-based in both the U.S. and international markets, and management said machine translation has driven four times incremental growth in daily users, and that should be a tailwind as it rolls the technology out to more countries.

Google searches featuring the word "Reddit" have also jumped over the last year as it has become the sixth most-googled word in the U.S., showing that internet users trust the platform to get advice or answers to questions that are too complicated for a typical Google search.

Image source: Getty Images.

Reddit's unique advantage

Reddit is different in a number of ways from other social media platforms like Meta's Facebook and Instagram.

First, Reddit is entirely anonymous, giving users more freedom to say what they want or explore taboo topics. It is also almost entirely text-based, unlike other social media platforms such as Facebook and Instagram, which are more centered around images and videos.

Reddit's differentiated platform now seems to be catching on with advertisers in a way it hasn't before, and Reddit's thousands of subreddits offer advertisers the opportunity to target specific audiences through subreddits that match their products.

With advertisers looking for new ways to reach new audiences, and ad demand bouncing back after a lull in 2022, Reddit's IPO and push into advertising seem to be well timed.

Is Reddit a buy?

With a combination of strong user growth, booming advertising demand, the emerging data licensing business, and improving margins, Reddit is executing flawlessly right now.

Investors also liked its fourth-quarter guidance as the company is calling for revenue of $385 million to $400 million and adjusted EBITDA of $110 million to $125 million.

It won't be growing revenue at nearly 70% annually forever, but the company is cashing on its differentiated position in social media, and building its data licensing business, which could soon be a significant revenue stream, based on its soaring growth. After all, Reddit's trove of content offers some of the best data for AI training, especially since it comes organized by hundreds of different subjects.

Looking ahead, Reddit seems to have the right combination of ad-based growth and the long-term benefit of data licensing. And like other social media businesses, the company has the potential to deliver wide operating margins as the business model is highly scalable.

Considering its rapid growth, improving margins, and potential in AI, Reddit stock looks like a smart buy.

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. Jeremy Bowman has positions in Meta Platforms. The Motley Fool has positions in and recommends Alphabet and Meta Platforms. The Motley Fool has a disclosure policy.