Twitter (TWTR) reported the results of its 2014 second quarter after the close of trading on Tuesday, and frankly, the company crushed it. In the most important metric for the company, active user growth, Twitter reported quarterly growth of 6.3%, after having reported only 3.9% growth in the previous quarter and 5.8% growth in the quarter before that. These unassuming numbers tell a most assuming tale: the apparent slowing of growth last quarter gave the Street the impression that Twitter was near to topping out in subscribers, and analysts, myself among them, were quick to explain that everyone who might possibly want Twitter already had it, and that Grandma and Grandpa would never figure out how to use it.
We were all wrong. Twitter's growth rate is actually accelerating, and that changes everything, or almost everything.
Twitter's revenue growth beat expectations as well. At $312 million, Twitter made more than twice as much as it did in the year ago quarter. The suggestion is that there are more ways for Twitter to make money than most analysts knew. Finally, the extra revenue actually caused Twitter to break into positive earnings ($0.02 per share), at least on a non-GAP basis. It is always better to make money than to lose it.
Allow me to state that I'm impressed, and lest it seem as though I'm dismissing the earnings report as unimportant, allow me to state that the future looks much brighter for Twitter today than it did at this time yesterday. So why name Twitter a dog? Well, I mean that from an investor's perspective. Though less silly looking today than yesterday, TWTR stock still looks like a loser. Why? Because the numbers still don't work.
If you were stupid enough (you heard me) to buy TWTR stock on its IPO day, but not in its IPO, congratulations on encouraging the worst of Wall Street's current excesses, the obsessive need to make billionaires of every enfant terrible who manages to create a new social network, whether or not said enfant has made any money for anyone, ever. Also, congratulations on being profitable—the best of all possible outcomes is a reality, and as a result, your stock is now worth $46.50 per share, when you only paid $44.90 for it nine months ago.
Wait… the best of all possible outcomes? Yes, that's right. Twitter went beyond what anyone thought they could do in the nine months since the IPO, and the stock rose by $1.40, or 3%. You may assume that if Twitter had done only slightly worse, if it had merely hit the most optimistic projections of what it could possibly do, you would be unprofitable. If you aren't quite sure why analysts tend to harp on P/E Ratios and other stock valuations, this is the reason. What a very high valuation says is that the best possible outcome has been assumed, and depending on how lofty that valuation is, the longer it has been assumed that it will continue.
And that brings us to Twitter's current valuation. It is grossly unfair to point to a company's P/E Ratio the moment it crosses into profitability, since it may be astronomically high without actually saying anything negative about the company. And yet I find I can't resist: Twitter's profit of $0.02 gives the company a current P/E Ratio of 2,342. Forecasts place its fye 2015 P/E at a somewhat more respectable 173. So really, Twitter needs to increase its revenue by a factor of five to ten without increasing its expenses just to justify its current price. If this sort of analysis bores you, I'll cut to the chase: that's bad.
The more realistic numbers are the company's Price to Sales Ratio of 28 and its Price to Book Ratio of 7.67. These are not terrible, for a rapidly growing company, which Twitter is, and for a company with plenty of room left to grow… but that, Twitter is not. This just isn't Facebook (FB), and 6.3% growth does nothing to change the perceived value of the “twitterverse” to most of the world. Which is nil.
It comes to this: if you think Twitter can somehow get everyone who posts pictures of the grandkids on Facebook happily tweeting away, TWTR stock makes sense. If you think it will fall anywhere short of that, look elsewhere.
Julian Close has been a business writer since the first day of the twenty-first century, having written for PRA International and the United Nations Department of Peacekeeping. He graduated from Davidson College in 1993 and received a Master of Arts in Teaching from Mary Baldwin College in 2011. He became a stockbroker in 1993, but now works for Fresh Brewed Media and uses his powers only for good. You can see closing trades for all Julian's long and short positions and track his long term performance via twitter: @JulianClose_MIC.