Reddit Stock Navigates A Changing AI Landscape

A Smooth IPO Hits AI Headwinds

Since its public debut on March 22, 2024, Reddit (NYSE: RDDT) had been a standout success story. The tech stock soared over 360%, and even after a significant 61% correction earlier in the year, it rebounded impressively by about 144%.

However, the positive momentum came to a halt last week. The social media platform's stock took a major hit following reports that OpenAI's ChatGPT was significantly reducing its use of Reddit's user-generated content. Data from AI search tracker Promptwatch revealed a dramatic drop, with Reddit content citations in ChatGPT responses plummeting from over 14% to just 2%. This change was reportedly triggered by Alphabet's Google altering its content indexing rules, which limited the data ChatGPT could access.

The market's reaction was swift and negative. Between September 29 and October 1, RDDT shares fell by more than 16%. With Google still in control of search and its own AI, Gemini, competing for AI market share, investors are now asking a critical question: will this reduced reliance from major AI models continue to hurt Reddit's stock?

Reddit's Resilient Business Model

Despite the recent turbulence, Reddit's primary revenue driver—online advertising—remains strong and unaffected. Furthermore, the company has been actively building a new revenue stream through licensing agreements, allowing AI companies to use its vast library of user content for training purposes.

This strategy includes a major partnership with Google established in February 2024. The multi-year deal, valued at a reported $60 million annually, gives Google's AI models access to Reddit's data. In return, Reddit gains access to Google's AI technology to improve its own platform. Just a few months later, in May 2024, Reddit signed a similar agreement with OpenAI, worth up to $70 million per year.

Advertising, however, continues to be the company's financial backbone. In its Q2 earnings report on July 31, Reddit announced ad revenue of $465 million, an 84% increase year-over-year. The number of active advertisers also climbed by 50%, boosted by new offerings like Dynamic Product Ads and AI-powered Community Intelligence solutions.

Profitability and Valuation Under the Microscope

While the AI data licensing strategy is promising, the news about ChatGPT scaling back its usage raises questions about Reddit's long-term role in the generative AI ecosystem. CEO Steve Huffman addressed this during the July earnings call, noting in his comments that millions of users rely on Reddit for human answers that AI summaries can't provide. He emphasized that the authentic conversations on the platform are essential for training large language models.

Beyond the AI headlines, investors have other concerns regarding Reddit's valuation and profitability. Although the company has posted positive net income for four straight quarters, it has yet to achieve profitability for a full fiscal year. The company's forward price-to-earnings (P/E) ratio of 62.50, while an improvement, is still high enough to make some investors cautious. Additionally, total liabilities grew over 46% from 2023 to 2024, and EBITDA contracted by a staggering 409% year-over-year.

Despite these challenges, Reddit's earnings are projected to grow nearly 95% in the next year, from $1.12 to $2.18 per share.

What Wall Street Thinks About RDDT

Institutional ownership in Reddit is robust, standing at over 82%. Over the last year, institutional buyers have outnumbered sellers, leading to net inflows of over $7 billion. However, Short interest is also significant at 16.48% of the float, suggesting some market skepticism.

This has led to tempered forecasts from analysts, who have given the stock a consensus "Moderate Buy" rating. The average 12-month price target, however, currently indicates a potential downside of 3.77%. Ultimately, the company's strong projected earnings growth may be key to overcoming recent negative headlines as it works toward sustained profitability and a more attractive valuation.