It’s a special thing to redefine what it means to be part of a “community.” Yet, that’s exactly what Reddit, known colloquially as “the Front Page of the Internet,” has done.

With billions of posts capturing 20+ years of human interaction and conversation, Reddit is an unrivaled corpus of human experience, which is very valuable — just ask the AI companies paying tens of millions of dollars for licensing rights to Reddit’s data, such as Alphabet and OpenAI, to help their models understand how to communicate like a human.

Reddit’s business is at an inflection point, rapidly growing its advertising business, building its own AI chatbots, and quickly growing internationally, all of which have combined to help Reddit reach profitability for the first time last year while leaving plenty of room for optimism about how this emerging social media giant can grow going forward.

The future is promising, but is the stock too richly priced? Let’s find out below and, as always, decide whether to add Reddit to our ongoing portfolio of long-term stock holdings known as The Intrinsic Value Portfolio (featured at the bottom of this newsletter.)

— Shawn & Daniel

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Reddit: The Front Page of the Internet

In a world of AI, Reddit is authenticity. Given the platform’s pseudonymous nature, users are actually empowered to be more real than they otherwise would be when bound by their own identities.

Not sure what I mean? To see this effect in action, go into r/jobs, the jobs subreddit, ask for career advice, and contrast that with the advice you get on LinkedIn, where everyone is strictly bound by their corporate identities.

While unfiltered and sometimes crass, people on Reddit will not hesitate to tell you how it really is. Candid feedback is the default.

On LinkedIn? Well, come on. LinkedIn is a laughably sanitized environment by Internet standards; everyone is presenting a corporate image of themselves: polished, intelligent, and without controversy, but also 100% synthetically inhuman.

Not to just beat LinkedIn into the ground here, but you get the idea. Reddit is the exact opposite, so much so that 40% of the internet deems Reddit recommendations as their most trusted factor in purchasing decisions (see below.)

Reddit’s biggest strength from a user perspective belies its biggest weakness as a business: Social media platforms primarily monetize themselves through ads, but how does one build an ad business around a company that aims to know as little as possible about its users?

Reddit doesn’t demand your real name, zip code, occupation, or any other similar data that Facebook has famously abused to the tune of hundreds of billions of dollars in value.

In other words, Reddit knows comparatively less about you, which is why it’s so popular (people are free to “be themselves”), but this is also why Reddit has been a bad business for a long time.

This explains why I (Shawn), after having used Reddit for nearly a decade, chose to sell out immediately after participating in its IPO at the sweetheart price of $34/share. I locked in a 50% gain and felt pretty smart, capitalizing on the company’s effort to offer IPO shares to long-time users and moderators until the stock quickly ran up to become a 6-bagger in the following months.

I missed out big time, but in hindsight, it was the “right” decision from a first-principles perspective. I certainly gave up some upside (okay, a lot of upside), but I also hadn’t seriously studied the company’s underlying business and, rightfully, noticed that the company had failed to successfully make itself profitable after two decades. Not a good sign; Facebook, for context, took five years to reach profitability.

I was purely trading Reddit, which I knew to be a form of “gambling,” and thus took a very small stake and treated it purely as fun (and that’s okay to do from time to time as long as we know we’re gambling!) Now, I’m revisiting Reddit with sober eyes.

I can’t recall ever seeing an ad before 2023 on the platform (not to say there weren’t any, but they were and far between and probably of low quality), and I was pretty sure that sales of so-called Reddit Coins — the virtual currency used to purchase awards that can be given to others for insightful posts — weren’t that lucrative of a business.

Reddit was a bad business, or at least a grossly under-monetized one, but that isn’t the case anymore.

The Times, They Are a-Changin’

A lot can change in a year. Since I made that regrettable decision, Reddit has found the light. In Q3 2024, the company became profitable for the first time and extended that delightful trend once again in the fourth quarter.

To Reddit’s credit, the business is churning on all fronts, with advertising dollars growing 71% year-over-year while daily active users grew almost 40%.

Even more promising, though, is that the company is fast discovering how powerful economies of scale can be for an accelerating internet business, as operating margins have improved from -24% in 2022 to -13% in 2023, 2% in Q3 2024, and then to 12% in Q4 2024. What a swing!

A 36 percentage point improvement in operating profit in two years is no small feat, highlighting how overhead, marketing, R&D, and other costs don’t scale proportionally with sales for companies with massive online platforms like Reddit. That dramatic inflection toward profitability shows no signs of stopping, either — I expect 2025 to be even more promising.

The bigger question we’ll get to in the valuation section is determining the degree of operating profitability Reddit can achieve once it matures.

Reddit has considerably improved its earnings power, increasing its inventory by unlocking new types of ad placements (like sponsored comments, since comment sections are lively places on Reddit, and “Ask Me Anything” sessions) while improving its interface for advertisers by providing more tracking tools and enabling more sophisticated sponsorship campaigns.

What Reddit lacks in individual user-level data, it makes up for with passionate communities. No, you can’t precisely geolocate an ad campaign to target people in an exact area, like the city your small business operates in, but you can make up for that by placing your ads in front of a highly engaged audience primed to interact with your advertisement at that moment.

Facebook thrives at delivering ads to very specific types of individuals, yet that doesn’t guarantee they’re in the right headspace to see an ad. Yes, your bakery’s ads targeting me because I live in a certain town might be reaching the ideal target customer in theory, but if I just had lunch before seeing your ad, it’s not exactly going to drive me to make an impulse purchase of croissants for pickup.

But with Reddit, you can deliver ads directly to users of r/baking, a community of 3.7 million bakers so passionate about their craft that they’ve sought out a community of like-minded individuals for recommendations, recipes, and feedback.

This works especially well for nationwide brands that are less location-sensitive about who they market to but care a whole bunch about finding people passionate about a given niche.

Imagine a Reddit post in r/baking chock-full of comments debating the best type of blender to use and then inserting an ad for your blender right in the middle of it.

This is clearly very powerful and extends to Reddit’s thousands of subreddits, each one specifically catering to a certain type of niche, from supplements to fitness, investing, fantasy books, Call of Duty video games, hiking, travel, parenting, and everything in between — incredibly fertile terrain for advertisers of all stripes.

Free Labor(!)

Beyond improvements in ads, including attracting more advertisers and higher quality advertisers, Reddit’s business benefits structurally from the army of moderators who manage its communities entirely for free, setting posting rules, deleting spam, and banning parasitic users.

This, again, is what makes Reddit special. Reddit is a decentralized place. Unlike TikTok, Instagram, X, and Facebook, there’s no central feed based on who you follow, at least not quite in the same way. Your feed is instead curated by the communities (subreddits) you interact with, making Reddit distinctly less influencer-driven and also very democratic.

Posts only rise to the top as they’re upvoted by users in the subreddit they're posted to, not because a user has a large following and gets a boost from the algorithm at the start. It’s thus more meritocratic than other social media sites.

And, as I mentioned, moderators proudly volunteer time to manage their favorite subreddits, helping organize and foster civil conversation while weeding out the stuff that makes other platforms so distasteful at times.

Being a moderator for a popular subreddit is a rite of passage for some, a position of power worth far more than any currency. Seriously, moderators are often what you might nicely call “chronically online,” and the clout that comes with moderation is of considerable significance to them.

From the company behind Reddit’s perspective, this is a wonderful advantage. They have a devoted, almost cult-like base of users who manage the platform’s vibrant communities without compensation. That, in theory, should allow Reddit to be structurally more profitable than many of its peers, as it needs to invest considerably less in technology and employees for content moderation and oversight.

The Elephant In The Room: Google

Reddit has long been a digital town square and the internet’s pulse, as measured in upvotes and downvotes. Reddit has over a hundred million daily active users on average and, in terms of brand recognition and search volume, ranks up there alongside companies like Netflix — Reddit is the sixth most searched term on Google.

Now, that’s partially a testament to its popularity, especially with the younger generation, but it also reveals that Reddit has long had a poor interface and worse search functionality. Ironically, it is often easier to add “Reddit” to the end of a Google search query to find the information you want on Reddit than it is to use Reddit’s own search bar.

This has created a symbiotic relationship with Google, where Google has come to recommend Reddit more for searches since nearly every topic has been discussed in depth there and because the feedback on Reddit is so highly valued, and Reddit has come to rely heavily on Google for much of its traffic, as much as half of it.

Traffic from Google is great until even just brief changes to the search engine’s algorithm cause massive swings in visitors to Reddit, breeding uncertainty over how stable Reddit’s user base actually is. Reddit’s goal is to convert these digital tourists, using Google to find specific answers on Reddit, into scrollers who download the app and treat it as a form of entertainment.

Awkwardly, Reddit is looking to monetize its corpus of user data not just by licensing its data to AI companies, as mentioned earlier, but also by building its own LLM trained specifically on Reddit posts known as Reddit Answers.

I say this is awkward because you’d presume that, if Reddit is competing with Alphabet in the world of AI chatbots and search, then Google would eventually be less inclined to recommend Reddit going forward, cutting off an important source of traffic for Reddit.

Now, Reddit CEO Steve Huffman has said he views Alphabet as a close partner and has no fear about this dynamic working against them, but I remain less convinced. Nevertheless, I will be closely watching Reddit’s ability to convert visitors who frequent its site without creating an account into bonafide users who are more monetizable and stable (visiting Reddit by app, intentionally, rather than through Google.)

Reddit-nomics

Reddit’s most valuable asset is its community (a community of communities, you might say.) Each new user adds incremental value not just by consuming content but by generating it — fueling a cycle of engagement that drives more users to the platform, expanding it into increasingly niche areas and attracting users focused on those niches.

The beauty of this growth model is that it is largely self-reinforcing, as there’s a home for anyone on Reddit, though branching out beyond the U.S. has been easier said than done.

Reddit is highly dependent on the U.S., with more than 40% of its users there, but it’s keen to change that. Reddit’s next chapter will be focused on expanding the platform internationally so that its user base better reflects the word’s population distribution (i.e., U.S. users at 4% of total users, not 40%.)

This demands a light touch. Communities must arise organically, reflecting real people’s passions, so how do you get more people to join Reddit in different countries and create culturally relevant subreddits in those areas?

Paid marketing will increase awareness but not necessarily foster new communities, so Reddit doesn’t do much of it. Instead, they reach out to people they think are uniquely qualified to launch subreddits outside the U.S. and provide resources on how to best moderate new communities.

More interesting than bootstrapping communities in various countries is the company’s initiative to translate content into any language, removing barriers and making any post and subreddit accessible to anyone worldwide, regardless of the language it’s posted in.

This is great for scaling adoption and making Reddit’s body of valuable recommendations, first-hand experiences, and other shared information more accessible. Consider, for example, that some of the best recipes for Chinese food in the world might be in a Chinese subreddit, making those delicious insights unavailable to the non-Chinese speakers of Reddit (which is most of Reddit.)

Using machine learning and AI, Reddit can increasingly make that, well, no longer an issue, freeing some of the best family recipes for Chow Mein the world has ever seen from the confines of language.

To capture the nuances of the jargon and vernacular used across Reddit, accurate translation across language is no small effort, but Reddit is slowly scaling this feature and expects to offer translation between half a dozen or so languages by the end of 2025.

Again, this makes more subreddits available to more types of people, which is great for user growth, engagement, and also advertising.

Valuation & Portfolio Decision

There’s a lot to like about Reddit. It has proven it can grow internationally with ample room to continue doing so. Reddit’s total user base is a small fraction of Facebook’s (3 billion monthly users), Instagram’s (2 billion monthly users), and about a third of X’s estimated daily users, despite having the potential for universal appeal — I truly believe there’s a subreddit for everybody!

And the flywheel around its advertising is beginning to spin faster and faster as the company pours millions of dollars into refining its advertising technologies for sponsors tapping into Reddit’s rich ecosystem of discussion and recommendations.

This reveals why advertising revenues can grow 31 percentage points faster than new users (71% YoY vs. 40%) — Reddit has had plenty of low-hanging fruit to pick in making their platform more advertiser-friendly.

As a result, Reddit should be able to increasingly close its ARPU gap (average revenue per user) with Meta, which earns roughly 3x as much per user as Reddit.

Part of this will be more inventory, better targeting, and simply awareness amongst corporate sponsors who increasingly see Reddit as a legitimate advertising destination, as well as Reddit’s international growth, making the platform more attractive to global brands.

Reddit’s international ARPU is growing at 13%+ per year compared with 6% per year for U.S. users (from 2022-2024), underscoring a double tailwind: International adoption of Reddit is growing faster than in the U.S., and international users are becoming more valuable, too.

In other words, the amount of money Reddit earns per user outside the U.S. is growing at twice the rate of U.S. users, reflecting A) how Reddit had under-monetized international users for years and B) is now meaningfully changing that.

At the same time Reddit is beginning to flex its muscles, the business continues to benefit from the economies of scale I mentioned earlier.

Operating margins have dramatically improved, and 2025 will likely be the company’s first full year of profitability. With operating margins at 12% in Q4 2024, the question I keep asking myself is what margins can look like five years from now?

To illustrate Reddit’s economies of scale in action, consider the following: Reddit spent $142 million in Q2 2024 on R&D, representing 51% of revenue. By Q4, they were investing $187 million in R&D — an increase of more than 30%(!) — yet, because revenue grew even faster from $281 million to $428 million, R&D costs as a percentage of revenue fell to 44%.

That’s a seven percentage point improvement in operating profit margins while the company continued to dramatically reinvest in its technical capabilities.

That’s a wonderful thing: If your business is growing fast enough, you can aggressively reinvest in yourself, deepening competitive moats while still boosting profit margins. Advantages compound, as R&D spending makes advertising more effective and adds features to the platform that enhance the user experience, enabling the company to spend even more on R&D while margins grow — the Big Tech names of the last decade know this formula quite well.

With user growth compounding at 20% a year in the last few years and ARPU growing, too, I think Reddit can plausibly double its user base by 2029, providing enough scale for operating margins to rise north of 30%.

For reference, Meta’s operating margins are above 40%, and while Meta has more user data and a larger scale of users, Reddit benefits from the unpaid army of moderators who sustain its platform, structurally supporting Reddit’s profitability (by reducing overhead costs as fewer employees are needed.)

Using a range of exit multiples of operating profit (aka EV/EBIT), from 24x operating profit to 46x, reflecting a variety of plausible market environments and sentiments surrounding the company depending on its outlook in 2029, I derive a weighted-average share price target of between $100 and $110 per share with a 25% margin of safety. This target implies a 12%+ return over the next five years if we can snap up shares in this range.

It’s not an exact science, but if we look at Airbnb, another powerful but slightly more mature platform/network effect company, it trades at a nearly 30x multiple of operating profits, while Spotify trades at 59x.

As a result, I feel that my range of exit multiples — the valuation I think the stock could trade at by the end of a 5-year holding period, is reasonable given how fast Reddit has grown and will probably still be able to grow in a few years.

This also doesn’t account for higher-than-expected operating margins thanks to scale or revenues from its tangential business units, like data licensing, something that doesn’t only appeal to AI companies but also financial firms: Intercontinental Exchange recently signed a deal for access to real-time Reddit data to gauge market sentiment and spawn related financial products, no doubt inspired by the power of the Wall Street Bets movement and its ability to move markets, as was most clear with GameStop’s meteoric 2021 rise.

As always, you can listen to Daniel and I’s corresponding podcast breakdown for more information on Reddit, but we are taking this chance to build a small position in Reddit, given that Reddit hit our price target earlier this week. (Note that the podcast was recorded earlier when Reddit was more expensive, so we passed at that time, but now the price has moved significantly enough to be attractive.)

Final Thoughts

I’ll be the first to say that, for a company like Reddit, with so much growth at its fingertips while inflecting to profitability, there’s a wider-than-usual range of possible outcomes when looking out 5 years.

Maybe operating margins never exceed 20%, or user growth hits a wall due to changes in Google’s search algorithm, or perhaps international ARPU remains stagnant and doesn’t narrow in on U.S. ARPU, or maybe the surprises are to the upside, with operating margins exceeding 40% and user growth considerably more than doubling — there’s a wide range of realistic outcomes for Reddit, meaning that there’s a wide range of intrinsic value calculations one could come up with for this company.

Contrast this with VeriSign, a company we covered a few weeks ago with an all-but-guaranteed business with little growth and uncertainty.

If you look at Reddit and get a valuation half ours, or twice as much, that doesn’t surprise me, which is why Reddit will be such a fun company to continue following and initiate a small position in. I’m incredibly optimistic about how they can grow internationally and continue earning more money per user, but not everyone agrees with me — Feel free to download and play around with our model for Reddit here.

Weekly Update: The Intrinsic Value Portfolio

Notes

• We initiated a starter position earlier this week in Reddit at an average price of $87.80, adding it to our portfolio with a 3% weighting. If the price falls below $70 per share, we may increase the position further
  
  

• Alphabet fell into the $150s last week, which we continue to see as very attractive; we increased our position slightly from 6.5% to 7% of our portfolio (at cost), bringing our average cost per share down to $182.82 for $GOOGL ( ▼ 3.4% ) 

Quote of the Day

"The credit belongs to the man who is actually in the arena, whose face is marred by dust and sweat and blood; who strives valiantly; who errs, who comes short again and again, because there is no effort without error and shortcoming…who at the worst, if he fails, at least fails while daring greatly, so that his place shall never be with those cold and timid souls who neither know victory nor defeat.”

— Theodore Roosevelt

What Else I’m Into

📺 WATCH: Why governments are addicted to debt

🎧 LISTEN: Common Stocks and Common Sense with Kyle Grieve

📖 READ: The Most Important Thing by Howard Marks

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