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Is Twitter Undervalued After a Sell-Off?

After reaching all-time highs near $75 per share, Twitter (NYSE: TWTR  ) shares have sold off to levels around $60 as many investors took their gains. Is the sell-off a buying opportunity? Probably not; comparing the stock to Facebook (NASDAQ: FB  ) shows just how incredibly expensive it is.

Source: Twitter.

Comparing Twitter to Facebook
Twitter is certainly a growth stock, and a premium valuation is expected -- but to this degree? The stock trades at about 59 times sales, easily trumping Facebook's comparatively meager valuation at 22 times sales.

But is it fair to compare Twitter to Facebook? After all, Facebook is a mature, large tech stock, while Twitter still has a long runway ahead of it ... right?

Measured by monthly active users, Twitter's growth is already decelerating. Maybe Twitter isn't the out-of-this-world growth stock it's priced to be? In the third quarter of 2013, Twitter grew its monthly active users, or MAUs, by 6.5% sequentially. During the same period in the year before, Twitter grew its MAUs by 10.5%. That's a significant slowdown in sequential growth rates from one year to the next.

Sure, Twitter's third-quarter sequential growth in MAUs of 6.5% beats Facebook's at 2.9%, but the fact that growth is already decelerating so rapidly should provoke caution in investors' growth outlook for the stock.

My favorite comparisons
Here are my two favorite ways to compare Twitter and Facebook

1. Market capitalization per daily active user

Twitter trades at about $320 per daily active user, or DAU, and Facebook trades at about $192 per DAU. While investors definitely expect incremental revenue from Twitter's growth in MAUs and DAUs, growth also comes from finding new ways to monetize its existing user base. And does Twitter's potential in this area really look more bullish than Facebook's? Considering the simplicity of Twitter's platform versus Facebook's arguably more comprehensive network, it would seem intuitively easier for Facebook to find new ways to monetize its user base. Yet Twitter trades at a significant premium to Facebook when valued per DAU.

2. Forward P/E
For Twitter to trade at a similar P/E as Facebook at Twitter's current market cap, it would need to need to report over $300 million in annualized net income. But this scenario looks way, way off. Twitter only reported about $500 million in revenue in the past twelve months, and has yet to report a profit. And keep in mind that Facebook's P/E isn't conservative by any means.

A watchlist stock
I'd presume that even Twitter management would have been euphoric to know shares would soon be trading at $60 shortly after going public at just $26. While I certainly wouldn't short a company with such a focused concept and a powerful network effect working in its favor, I also wouldn't buy it at today's price.

The nice thing about investing is that I can calmly keep the stock on my watchlist and reconsider the stock at a later date if the price falls. While Twitter could prove to be more successful than I expect, investors would do better to wait until optimistic prospects for the business and the stock are more certain.

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Daniel Sparks

Daniel is a senior technology specialist at The Motley Fool. To get the inside scoop on his coverage of technology companies, follow him on Twitter.

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Related Tickers

8/31/2015 4:00 PM
TWTR $27.79 Up +0.96 +3.58%
Twitter CAPS Rating: ***
FB $89.43 Down -1.58 -1.74%
Facebook CAPS Rating: ***