Reddit, Inc. (RDDT): Navigating Legal Storms and Traffic Headwinds—A Viable Long-Term Bet?

In the fast-evolving world of tech stocks, few stories have been as polarizing in 2025 as Reddit, Inc. (RDDT). The social media giant, once celebrated for its explosive revenue growth and high-margin business model, now finds itself at the center of a securities fraud lawsuit and grappling with existential threats from Google's AI-driven search algorithms. For investors, the question is no longer just about Reddit's ability to monetize its massive user base, but whether it can survive the perfect storm of legal, regulatory, and market forces reshaping the digital landscape.

The Legal Quagmire: A Class Action Over AI and Traffic Decline

The Tamraz, Jr. v. Reddit, Inc. lawsuit, filed in June 2025, accuses Reddit and its executives of misleading investors by downplaying the impact of Google's AI Overviews on user traffic and revenue. The core allegation is that Reddit failed to disclose how Google's “zero-click” search feature—where AI-generated answers appear directly in search results—has drastically reduced the need for users to visit Reddit for information. This shift, the lawsuit claims, led to a 30% drop in Reddit's U.S. daily active user (DAU) growth in Q1 2025 and a subsequent 9% stock price plunge after a Baird analyst downgrade.

The legal risks are twofold. First, a successful class action could force Reddit to pay substantial damages, eroding its $635 million cash reserves. Second, the litigation has cast a shadow over the company's credibility, with investors now scrutinizing its public statements more closely. As of August 1, 2025, the lead plaintiff deadline for the lawsuit is fast approaching (August 18), and the outcome could set a precedent for how companies disclose third-party AI risks—a critical issue in an era where tech giants increasingly rely on external platforms.

Financial Resilience Amid Traffic Turbulence

Despite the legal drama, Reddit's Q2 2025 financials are undeniably impressive. Revenue surged 78% year-over-year to $500 million, driven by a 84% jump in advertising revenue and a 24% increase in “other revenue” (data licensing deals with AI firms like Google and OpenAI). Gross margin expanded to 90.8%, and the company turned a $89 million net profit—a stark contrast to the $10 million loss in Q2 2024.

However, these numbers mask a fragile reality. While global DAUs hit 110.4 million (up 21% YoY), U.S. DAU growth lagged expectations, with Google traffic volatility remaining a key drag. The company's reliance on logged-out users (50% of total traffic) is particularly concerning, as these users generate minimal ad revenue. Internally, the lawsuit alleges executives were aware of the traffic crisis but painted an overly optimistic picture to investors.

The Google Conundrum: A Battle for Digital Attention

The heart of Reddit's crisis lies in its dependence on Google. For years, the platform thrived on search traffic, with 50% of its users arriving via Google. But Google's AI Overviews have disrupted this dynamic, creating a “zero-click” loop where users never leave their search engine. The impact is clear: a niche website operator cited in the lawsuit reported a 90% drop in Google traffic in early 2025, a trend mirrored by Reddit.

Reddit's response has been to double down on AI-driven tools like Reddit Answers, which grew from 1 million to 6 million weekly active users in Q2. While this is a positive step, it's a reactive strategy. The company's ability to compete with Google's AI ecosystem—and to retain users who increasingly find answers without leaving search—remains unproven.

Regulatory and Valuation Risks: A Double Whammy

Reddit is also contending with new regulatory pressures, such as the UK's Online Safety Act, which mandates AI and age restrictions to protect minors. Compliance costs could strain its finances, especially if the company faces fines for noncompliance. Meanwhile, its valuation appears stretched. Trading at a forward P/E of 33.25 and a P/S of 12.6x, Reddit is priced for continued growth. But if user traffic declines persist, these multiples could collapse. Analysts project a 30% contraction in DAUs by 2026, which would likely trigger a 50% drop in ad revenue.

Investment Implications: Is RDDT a Buy, Sell, or Hold?

For investors, the calculus hinges on three factors:
1. Legal Exposure: A settlement or unfavorable court ruling could drain Reddit's cash reserves and depress its stock price.
2. Traffic Sustainability: Can Reddit diversify its traffic sources beyond Google, or will it remain vulnerable to algorithmic shifts?
3. Monetization Potential: The company's AI licensing deals and international expansion offer upside, but these must offset declining U.S. ad revenue.

Recommendation: RDDT is a high-risk, high-reward bet. While its Q2 2025 earnings and AI initiatives show promise, the legal and traffic headwinds are significant. Investors with a high-risk tolerance might consider a small position, but only if they're prepared for volatility and a potential decline in valuation. For the long term, Reddit needs to prove it can adapt to a world where Google's AI dominates the attention economy—a challenge it hasn't yet met.

In the end, the Reddit story is a cautionary tale for the AI age: even the most profitable tech companies are not immune to the ripple effects of innovation they can't control. For investors, the lesson is clear—diversify, hedge legal risks, and never bet the farm on a company's ability to outmaneuver a tech giant like Google.