Twitter May Trade Higher, But Should You Buy?

In the case of Twitter (NYSE: TWTR  ) , market momentum, technicals, and sentiment is telling you to buy. Fundamentals are telling you to avoid or sell. This tug-of-war is one of the toughest games an investor will play. But thankfully, there are other great social media stocks with impressive growth and cheaper valuations.

An unprecedented premium
Twitter has surpassed its IPO highs with a price of $52.58. There has been no news to drive the stock higher.

By now, you know the story of Twitter, a small but fast-growing social media company with a big market capitalization. If analysts are correct, Twitter will report sales of $638 million in 2013 and $1.12 billion in 2014 . Hence, it is growing at almost 100% annually. The company is not yet profitable; Twitter has operating margins of negative 25%.

Clearly, the company's growth is impressive, and most believe that it will one day be profitable. Yet, the problem is its valuation, and the fact that Twitter is increasing its spending at a faster rate than it is growing revenue. This leaves some to wonder if such growth is possible with less spending.

With a current market capitalization of $28.3 billion, Twitter trades at 50 times sales. If the company is successful in producing $1.12 billion in revenue during 2014, it would trade at 24 times forward sales, and that's only if the valuation is unchanged. This multiple is, without question, one of the highest on Wall Street, and by far the highest of any $20 billion-plus company.

A large disconnect in valuation
If we look primarily at revenue multiples, both Facebook (NASDAQ: FB  ) and LinkedIn (NYSE: LNKD  ) are significantly cheaper and also have impressive growth.

Facebook and LinkedIn trade at 17.5 and 20.2 times trailing-12-month sales, respectively, which is far cheaper than Twitter's valuation on its 2014 sales. Clearly, this shows a huge disconnect in the valuation of these three social media leaders.

Moreover, LinkedIn and Facebook are profitable. LinkedIn has an operating margin of 4.5%, while Facebook has a 33.5% operating margin. The reason that Facebook's margins are so much greater is because the company has managed to accelerate growth while decelerating its year-over-year cost growth .

Which social media stock is best?
With social media being an industry that's still in its infancy in regards to advertising dollars, many of the big-name companies spend rapidly to try and gain market share. Yet, Facebook is the first company to find a consistent balance between growth and spending that has aided in its 90% return in 2013.

With that said, both Facebook and LinkedIn look to be better investments than Twitter. Both have growth greater than 50% annually -- and with significantly higher revenue. However, Facebook, for the reasons noted, has to be the clear winner.

Facebook has a whopping 1.19 billion users to monetize, while Twitter and LinkedIn have far fewer than 300 million. It is hard to determine if either of the other two will ever grow to the size of Facebook, especially considering that Twitter's North American user base is barely growing at 30% annually .

Another fact to consider regarding Twitter is the limitations of its business: Twitter is grounded to just 140 characters or less, while Facebook and LinkedIn can support much more engaging content, including games, apps, community pages, local business pages, blogs, etc., all of which have proven to be attractive to advertisers.

As of now, Twitter has much lower revenue per user, and much of the investment thesis revolves around whether or not Twitter can grow this metric from $2-$3 to $8-$12 like Facebook and LinkedIn. Once more, the answer to this question is speculative. But because of the rate that tweets become lost in a user's feed, investors have to entertain the idea that advertisers will never find Twitter to be as effective as Facebook or LinkedIn.

The Foolish bottom line
There are a lot of questions surrounding Twitter. Yet based on its multiple, this is a company that's valued for perfection. Granted, LinkedIn and Facebook are not cheap, either, but both companies have answered many of the lingering questions surrounding Twitter and maintain strong growth outlooks.

The tug-of-war between logic and emotion that surrounds Twitter will likely persist. But for investors seeking fewer questions, strong growth, and a cheaper stock, Facebook appears to be the best choice.

A great growth pick from the Motley Fool
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