Talk about a poor start. Twitter (TWTR) stock is already down 15% in 2016. And adds to the stock's already shockingly sharp decline last year. Factoring in this poor start to 2016, the stock is down a whopping 51% during the last 12 months.
Ouch.
While the decline is unfortunate for current shareholders, has a buying opportunity materialized amid the decline?
Understanding Twitter's valuation
There are a number of ways to put Twitter's valuation into perspective. Comparison to Facebook (META -5.01%) is particularly useful for context. Here are the two stocks compared on a few metrics:
|
Company |
Price-to-Sales |
Forward P/E |
Price-to-Book |
|---|---|---|---|
|
|
6.5 |
28.7 |
3.2 |
|
|
17.3 |
27.5 |
6.6 |
By direct comparison, Twitter is easily the cheaper stock of the two. And this is particularly interesting since Twitter is the faster-growing company. During Twitter's most recent quarter, for instance, the smaller social network's revenue soared 58% from the year-ago quarter. During the same period, Facebook's revenue climbed 41%.
But comparisons of two arguably pricey stocks -- at least when compared to slower-growing companies -- stops short of a more complete picture. It's worth totally analyzing Twitter's valuation by itself from the ground up.
Image source: Getty Images.
A closer look
One way to look more closely at Twitter's valuation is to come up with a conservative estimate of Twitter's EPS growth over the next five years and see whether the resulting stock price needed to earn investors a 10% annualized return during this period yields a believable price-to-earnings ratio.
Keep in mind: This scenario is completely theoretical and only meant to serve as a way to add some context to the low end of expectations.
Considering Twitter is still growing revenue at rates above 50%, yet this growth is decelerating, predicting the social media company could grow revenue about 20% annually over the next five years seems fairly conservative. And since Twitter's business model, like Facebook's, is scalable, the company should at least be able to grow EPS in line with revenue.
Twitter's revenue in recent quarters. Chart source: Twitter.
So, here's our theoretical scenario. Assuming Twitter can grow its current run rate of annual non-GAAP EPS at about 20% annually over the next five years and assuming its GAAP EPS catches up to its non-GAAP EPS, the company could conceivably be reporting about $1 in annual EPS by 2020. For investors who buy Twitter stock at $20 to earn a 10% annualized return throughout these five years, shares would be trading at about $32 five years from now. This would put Twitter's P/E ratio at about 32 in five years.
With this being what I believe is a very conservative estimate of Twitter's EPS growth over the next five years, this theoretical scenario does make the social platform company's valuation seem compelling. While a P/E multiple above 30 definitely represents a premium, this would be a respectable one for a company growing this strongly over a five-year period.
Furthermore, if Twitter manages to transform itself into a platform that attracts the masses, this prediction could prove to be far too conservative. So, when viewing this scenario as a conservative forecast -- which I believe it is -- Twitter stock at sub-$20 does look enticing.
While Twitter may not be a screaming buy yet, it's definitely starting to look compelling.
