Twitter’s Wild Ride: How to Decode the Stock’s Value

Source: Thinkstock

Source: Thinkstock

Twitter (NYSE:TWTR) has only been publicly traded since November, but already shareholders have been on a wild ride. After spiking from the mid $40s to nearly $75/share by December, the stock has traded back down to its IPO level. With earnings coming out on Tuesday, the shares hit a new low of $37/share on Wednesday despite beating earnings expectations.

Twitter grew its revenues by an astonishing 119 percent to $250 million for the first-quarter. While the company reported a net loss of $134 million, as a young company with a lot of expenses, it is more appropriate to look at the company’s gross profit, which came in at $143 million, or nearly triple the gross profit from the first quarter a year ago.

Investors were disappointed that Twitter’s user growth is slowing, and this is the justification for the shares hitting a new low since going public. However, there is one other glaring issue: the stock is incredibly overvalued.

Source: Getty Images

Source: Getty Images

Right now, the market is valuing Twitter at $22 billion, yet the company is not even making money. In a case like this, it is more appropriate to look at the company’s price to sales ratio as opposed to its price to earnings ratio. If we look at the company’s trailing revenues then we find that it has a price to sales ratio of about 27.5. This is incredibly high considering that Twitter has no profits and slowing user growth.

The reason that the stock trades where it does — and the reason that analysts are so bullish with an average $52/share price target — is the company’s incredible growth rate. We saw already that Twitter grew its revenues at 119 percent year-over-year, and while analysts don’t expect the growth rate to remain this high. they do expect incredible growth going forward. This, of course, assumes that Twitter will be able to further monetize its business, which is a problem that has been faced by social media companies from Facebook (NASDAQ:FB) to Google (NASDAQ:GOOG) (NASDAQ:GOOGL).

Ultimately, I do believe that Twitter will be able to further monetize its growing user base beyond what it has already accomplished. For this reason, the shares deserve to trade at a premium multiple to sales. But at the same time, a 27.5 multiple is simply outrageous — especially since the company has yet to generate a quarterly profit.

With this being the case, I think that for those who are bold enough to take a position in Twitter that they should do so at a lower price. Fortunately for these investors, the stock is in a well-defined downtrend, and there is no sign that this downtrend will abate any time soon. Furthermore, as the stock goes down, revenues should continue to rise substantially even if user growth is slowing. Thus, for those investors waiting for a more appropriate valuation such as 12-15 times sales, they won’t have to wait for a 50 percent-plus plunge in Twitter shares.

In the long run, Twitter should be a solid investment — it offers a service that has become invaluable. But for now it is incredibly difficult to value. For this reason, the best strategy is to wait and see what happens. If the share price continues to fall, and if sales continue to grow at a fast pace, then it will make sense for more aggressive investors to take a long-term position in Twitter shares.

Disclosure: Ben Kramer-Miller has no position in Twitter or in the stocks mentioned in this article.

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