Meet the Newest Member of the S&P 500. It's Up 365% Since Its IPO, and It Can Keep Climbing From Here.

The S&P 500 (SNPINDEX: ^GSPC) is widely regarded as the most important U.S. stock index. To be included in the index, a U.S.-based company must meet a set of criteria, including demonstrating consistent profitability. While the committee typically adds and removes constituent companies from the index quarterly, it occasionally needs to add a new company mid-quarter.

Such is the case with the most recent addition. After AvalonBay Communities merged with Equity Residential to form Vivmark, the index found itself one company short. The committee selected Reddit (NYSE: RDDT) to replace it. The social media stock made its market debut just a couple of years ago, but it's already up 365% from its IPO price as of this writing.

The good news is it's not too late to buy into Reddit. Some recent headwinds have created a buying opportunity for long-term investors.

Image source: Getty Images.

A lot to like, but will AI disrupt it?

Reddit shares sold off after the company reported its second-quarter earnings results. The financials were very strong. Revenue increased 61% year over year. Adjusted EBITDA margin expanded to 42.6% from 40.1% last quarter and 33.4% a year ago. It also repurchased $235 million in shares using its growing free cash flow to help offset stock-based compensation. Ultimately, earnings per share climbed an impressive 178% from last year.

But investors appear hung up on the fact that daily active users in the U.S. declined sequentially. It's just the latest signal that artificial intelligence is disrupting its business. AI Overviews on Google may be cutting off a key source of traffic for the platform, thereby slowing user growth in more mature markets.

That's important because Reddit makes most of its revenue from advertising. Other revenue, including data licensing for AI developers, accounted for just 5% of Reddit's total sales last quarter. Without a steady inflow of new users, revenue growth will eventually dry up.

To that end, Reddit is positioning its platform as an alternative to artificial intelligence. Instead of asking questions to an AI chatbot, you can ask a real community of human beings and get tailored answers with better nuance. Ultimately, management believes the platform will grow to 100 million logged-in users in the U.S. (up from 23 million) and 1 billion globally (up from 53 million). That suggests a long runway for growth.

Even with sluggish recent user growth, management has made significant progress in monetizing existing users. Average revenue per user climbed 36% globally and 51% in the U.S. last quarter. Continued improvements in its ad targeting and ad load optimization should provide another path to high revenue growth as management works to accelerate user growth.

Fears about AI disrupting its business have pushed the valuation to a very attractive 21 times earnings expectations. For a company capable of producing earnings growth of around 25% per year, based on analysts' estimates, that's a great price to pay and suggests the stock price could climb higher from here.

Adam Levy has positions in Alphabet. The Motley Fool has positions in and recommends Alphabet and Reddit. The Motley Fool recommends Vivmark Residential. The Motley Fool has a disclosure policy.