After flirting with record highs in the past few days, the Dow Jones Industrial Average (DJINDICES:^DJI), Nasdaq (NASDAQINDEX:^IXIC), and S&P 500 (SNPINDEX:^GSPC) were all lower in early afternoon trading Tuesday.
Twitter (NYSE:TWTR) was down over 11% to the stock's all-time low. The downward movement in the broader market is likely a temporary price shift after the record highs of the past few weeks, but for Twitter the correction is more troubling. Here are the three biggest reasons why.
1. Employees are selling today for the first time
Twitter has only been a public company since November 2013. As a newly public entity, employees have not been allowed to trade the stock they received while the company was still private.
This "lockup," as it's called, expired today, and has stoked a flurry of selling by company employees. It's hard to blame them, as many of these employees are sitting on a fortune of shares made as the company exploded from a misunderstood "microblog" to a household name in just the past several years.
That said, the majority of Twitter shareholders pledged not to sell today, meaning that the selling is being done by a minority of insiders, not the largest investment firms or founders.
Two of Twitters co-founders, Jack Dorsey and Evan Williams, both pledged not to sell any shares until at least October -- and their sales will based on a prearranged program with precise rules governing the trades.
Company CEO Dick Costolo previously announced he would follow the founders' lead and also not sell today.
These three individuals together own just shy of 15% of the company.
The company's largest institutional shareholders also pledged not to sell, led by 17.9% owner Rizvi Traverse Management. Other notable investors not selling today include 5.4% owner Benchmark Capital and 8.4% owner J.P. Morgan Asset Management.
This blip in insider selling is a short-term behavior, so anticipate some relief from this downward pressure as the week moves on. Unfortunately, there are other issues at play exacerbating the movement.
2. Where is the user growth?
Twitter has been on a pretty steep downward slope since reporting first-quarter earnings on April 29. The stock is down over 25% since April 23 and off nearly 50% over the past three months.
What about the first quarter roiled the stock so viciously? User growth.
Twitter's aim is to become a mainstream platform on the scale of Facebook (NASDAQ:FB). The company reported 255 million active monthly users, which on the face of it is a huge number. However, that number only increased by 14 million users in the first quarter, a disappointing result. At that pace, Twitter is not even close to approaching Facebook-like levels of adoption.
Worst yet, just 40% of those 255 million monthly active users use the service daily. That number is 63% at Facebook.
It's very difficult to justify Twitter's near-$20 billion valuation with these growth and engagement numbers.
3. The business is solid, but not $20 billion solid
On the earnings call for the first quarter, Costolo pointed to the company's acquisition of MoPub, a mobile ad network, as a huge success and indication of Twitter's future.
Costolo is absolutely correct in saying that, but the numbers at this point fail to justify the company's valuation.
Through its MoPub network, advertisers can access over 1 billion smartphone users. As consumers continue the shift from desktop PCs to laptops to smartphones and tablets, this is an amazingly valuable business with great upside.
But the MoPub acquisition last year was only a $350 million deal, barely a drop in the bucket compared to the $20 billion market cap where Twitter currently trades.
Twitter is building a very solid business. The company will certainly find plenty of profit as it executes its monetization strategy. However, the valuation today is simply too high based on the current numbers.
Explosive valuations in social media companies are a result of explosive growth and explosive potential. Without skyrocketing growth, Twitter's stock will likely continue to fizzle until it lands back on the ground. Once it does, the stock will represent a great value in what will become a very successful and profitable company.
Jay Jenkins has no position in any stocks mentioned. The Motley Fool recommends Facebook and Twitter. The Motley Fool owns shares of Facebook. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.