At The Motley Fool, we follow the official SEC filings from a wide variety of hedge funds, many of them led by billionaire investors. Recently, we noticed that four different funds bought over 7 million shares of Twitter (TWTR 2.25%) in the first quarter of 2016. Those moves are quite intriguing, since Twitter stock has been in free fall over the past year.
It's of utmost importance to do your own homework when investing, as opposed to blindly replicating the decisions of others. However, in the search for investment ideas for your portfolio, there is nothing wrong with taking a look at what the big money is doing. Twitter may be quite a risky proposition at this stage, but it also offers huge upside potential from current price levels.
A contrarian play
Twitter is going through considerable uncertainty. User growth is stagnant, and there has been a lot of turmoil in the company's management team over the last several months. Shares of the short-message social network are down by almost 40% in the last year.
The company ended Q1 2016 with 310 million monthly users, a disappointing year-over-year increase of only 3%. International users grew 4% to 245 million, and the user base in the U.S stands at 65 million, flat year over year.
Twitter just pales in comparison to Facebook (META -0.76%) in terms of both size and growth. Based on its financial reports for the first quarter of 2016, Facebook has a gargantuan user base of 1.65 billion monthly active users, an annual increase of 15%. Even if we focus only on Facebook users via mobile devices, the most dynamic segment, Facebook has 1.51 billion mobile monthly users, up 21% year-over-year.
LinkedIn (LNKD.DL) reports on its registered users as opposed to monthly active ones, so comparisons are not completely straightforward. Nevertheless, the professional network also seems to be doing much better than Twitter, with 433 million members as of the first quarter, representing an annual increase of 19%.
Many users find Twitter too complex and intimidating, or maybe they just don't understand the platform's value proposition. This is a major reason for concern, and investors in Twitter need to be willing to tolerate substantial uncertainty over the middle term.
Is this a buying opportunity?
Twitter is implementing a series of initiatives to jump-start growth. The company recently announced that it will be simplifying the language and making it easier for users to share content in different formats such as photos, videos, and GIFs. For example, media attachments will no longer count toward the 140-character limit; this should theoretically encourage users to share more photos, polls, GIFs, and video on Twitter.
Also, in a deal worth $10 million, Twitter has secured the rights to globally stream 10 NFL Thursday Night Football games during the 2016 season. This could be a smart way to attract more users and create more valuable content, and it could also pave the way for more video deals in different areas in the future. Video advertising is a key growth segment in the industry, so Twitter seems to be moving in the right direction.
One thing is quite clear: Twitter has enormous room to improve and make market share gains. According to estimates from eMarketer, Twitter will attract a minuscule 1.4% of global digital advertising revenue in 2016.
It's also important to recognize that its valuation levels are quite attractive. When comparing Twitter against Facebook and LinkedIn in terms of ratios such as forward price to earnings (P/E), price to sales (P/S), or price to book value (P/BV), the stock is clearly much cheaper than its peers.
Facebook and LinkedIn are doing materially better than Twitter, so they deserve higher valuation ratios. However, investment decisions need to be made by looking through the windshield at the road ahead, not in the rear-view mirror. If Twitter manages to deliver accelerating growth over the middle term, then the stock could offer huge gains for investors.