Reddit's Legal and Market Risks Amid Zero-Click Search Challenges

The digital landscape is shifting rapidly, and Reddit (RDDT) finds itself at the epicenter of a storm. The platform's once-robust traffic growth, fueled by search engine referrals, is now under threat from Google's AI-driven “zero-click” search algorithm. This trend—where users receive AI-generated answers directly in search results without visiting external sites—has sparked a legal and financial crisis for Reddit, raising critical questions about its long-term viability and valuation.

The Zero-Click Dilemma

By 2025, 27% of U.S. Google queries resulted in zero-click outcomes, a figure that has accelerated as AI overviews replaced traditional links to Reddit's content. For a platform that relies heavily on search traffic—50% of its users arrive via search, despite generating only 15% of ad revenue—this shift is existential. Internal documents cited in the Tamraz v. Reddit lawsuit suggest executives knew the severity of the issue but downplayed it to investors, assuring that the impact was “no different from past algorithm changes.”

The data tells a different story. Reddit's daily active user (DAU) growth has slowed to the high teens year-over-year, far below the double-digit growth it once projected. While logged-in users (who generate 85% of ad revenue) remain a lifeline, the platform's reliance on logged-out traffic—now 50% of total traffic—has become a vulnerability. A niche website operator cited in the lawsuit reported a 90% drop in search traffic in early 2025, a trend mirrored by Reddit's declining visibility in Google's algorithm.

Financial Performance: Growth vs. Sustained Viability

Reddit's Q1 2025 earnings report highlighted a paradox: strong revenue growth but shaky user metrics. The company reported a 61% year-over-year revenue increase to $392 million, driven by advertising and data licensing. Its stock surged 3.97% post-earnings, closing at $123.50. Yet beneath the surface, DAU growth in the U.S. actually declined compared to Q3 2024, while visibility tools like SEMRUSH showed traffic volatility tied to Google's algorithmic shifts.

Reddit's financials reflect a high-margin business (90.49% gross profit) but one with structural risks. The company's Adjusted EBITDA margin of 29% is impressive, yet its reliance on a shrinking user base for monetization creates a fragile foundation. With 108 million DAUs and 401 million WAUs, Reddit's scale is undeniable, but the quality of engagement—and its ability to convert free users into paid subscribers—is now in question.

Valuation: A House of Cards?

Reddit's valuation multiples are staggering. At a forward P/E of over 55x and a P/S of 12.6x, the company trades at a premium to industry peers like Pinterest (P/E ~40x) and far above historical averages for social media firms. Its enterprise value-to-EBITDA ratio exceeds 100x, a level typically reserved for pre-profit unicorns.

These multiples hinge on two assumptions: sustained user growth and effective monetization. Both are now under threat. If zero-click trends persist, Reddit's DAU base could contract by 30% by 2026, according to analyst projections. A 30% decline in users would likely trigger a 50% drop in ad revenue, given the platform's dependence on logged-in activity.

Legal Risks and Investor Sentiment

The Tamraz v. Reddit lawsuit adds a layer of legal uncertainty. If the court rules that Reddit misled investors about the impact of zero-click searches, the company could face penalties exceeding $100 million in settlements and legal fees. This would not only strain liquidity but also erode trust in management. The lead plaintiff deadline of August 18, 2025, looms large, and institutional investors have already reduced their exposure by 12% since the lawsuit was filed.

Investor sentiment has soured further as Reddit's stock price has dropped 17.8% since January 2025. Analysts from Wells Fargo and Baird downgraded the stock in May 2025, citing “existential risks” from algorithmic shifts. The stock's volatility has spiked, with daily swings averaging 1.6% in July 2025 compared to 0.8% in January.

Strategic Responses: A Path Forward?

Reddit's response to zero-click threats includes initiatives like Reddit Answers, an AI-powered Q&A feature, and a pivot to premium subscriptions. However, these efforts remain unproven. The platform's partnership with Google to integrate Reddit content into AI tools—a $60 million deal—risks further cannibalizing traffic while offering no guarantee of visibility.

The company's focus on logged-in communities and paid memberships is a step in the right direction, but scaling these features will require time and capital. Reddit's R&D spending of $437 million in Q1 2024—nearly double its revenue—highlights the urgency, but such investment comes at the cost of profitability.

Investment Implications

For investors, Reddit's story is a high-risk, high-reward proposition. The company's financials are strong, but its business model is under siege from both algorithmic and legal forces. The key question is whether Reddit can adapt to a world where search engines no longer drive traffic to its platform.

1. Hedge Exposure: Given the legal and operational risks, investors should consider hedging with options or reducing exposure to Reddit until the lawsuit's outcome is clear.
2. Monitor Traffic Trends: The success of Reddit Answers and other AI initiatives will be critical. If these features fail to retain users, the stock could face further declines.
3. Reassess Valuation Assumptions: Reddit's current valuation assumes a return to DAU growth and sustained monetization. If user declines accelerate, the P/E multiple may contract sharply.

In the long term, Reddit's survival depends on its ability to diversify traffic sources and innovate beyond search. Until then, the platform remains a speculative bet for those willing to navigate the turbulence of algorithmic disruption.