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Demand for Digital Advertising Is Exploding

Snap (NYSE: SNAP) and Twitter (NYSE: TWTR) just reported blowout earnings, and it bodes well for other digital advertising businesses like Facebook (NASDAQ: FB) and Alphabet (NASDAQ: GOOG) (NASDAQ: GOOGL).

Both Snap and Twitter saw revenue skyrocket, but the numbers that truly stood out were the increases in ad pricing on their respective platforms. While the second quarter of 2020 was an anomaly negatively impacting advertising demand, the recent results indicate advertisers' greater willingness to spend more on digital advertisements.

Digital advertisements are important to small businesses. Image source: Getty Images.

Diving into Snap and Twitter's results

Marketers paid 122% more per ad impression on Snapchat than they did in the second quarter last year. Twitter advertisers were paying 42% more each time a user engaged with an ad versus 2020.

Management from both companies pointed to the easy comparable, as well as product improvements that led to higher average ad prices on their apps. But the important thing for investors to consider is the value marketers are getting from their higher ad spend. The big driving force behind digital advertising has been the return on investment relative to other forms of advertising like television.

But improved return on ad spend wasn't clear at Snap. "The rate of growth in demand outpaced the rate of new optimizations delivered in the quarter, and we observed sequential increases in cost per action for our goal-based bidding products," CFO Derek Anderson told analysts during the second-quarter earnings call. In other words, advertisers were willing to spend more for each conversion, leading to a bigger increase in ad prices.

Twitter says it's still giving advertisers more bang for their buck. CFO Ned Segal said, "A return to global events, product launches, and our better ad products all [drove] improved advertiser ROI" in the second quarter. That said, the vast majority of Twitter's advertising still comes from big brands, which are primarily focused on reach and engagement first with less measurable direct objectives. And they're paying 42% more this year than last year for each ad engagement.

Both companies' results indicate demand is outstripping supply for digital advertisements, and that could mean much higher average ad prices in the second quarter for Facebook and Google, too, regardless of their own product innovations over the past year.

Accelerating the shift to digital

Snap and Twitter's blowout results may be just the beginning of several quarters of very good results for digital advertisers. While the quarters ahead provide tougher comparable periods for the industry, we saw a big shift in the advertising industry amid the pandemic.

Advertisers reduced their ad spending last year at the start of the pandemic. First, they pulled back spend on digital platforms because it's easy to turn off digital ad campaigns. That led to revenue declines at Twitter and Alphabet and slower revenue growth at Snap and Facebook.

As we moved to the summer, advertisers were able to pull back some of their television campaigns. Many rescinded their up-front commitments in the latter half of the year. Digital advertising quickly bounced back after that.

But now, after lapping the start of the pandemic, advertisers still seem to be leaning into the digital platforms. Snap's third-quarter outlook calls for revenue growth between 58% and 60% on top of the 52% growth it experienced last year. Likewise, Twitter expects revenue to increase between 30% and 39%.

It seems advertisers are willing to accept lower returns on their spending for now. The greater flexibility of digital advertising versus television while economic conditions remain uncertain may produce a premium for digital advertising today. Additionally, some marketers may find a declining and less engaged television audience produces worse ROIs for television advertising, which will allow them to pay more for digital alternatives.

Investors in tech stocks with lots of exposure to digital advertising should look forward to more strong results.

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