Twitter (NYSE:TWTR) stock is on a roller coaster lately. Shares of the short-message social network are down by over 40% in the last year, and they are suffering from tremendous volatility due to all kinds of rumors over the past several weeks. In this context, Twitter is attracting lots of attention from investors and the media.
The company is scheduled to report earnings on Oct. 27, and investors will closely scrutinize all available information in order to try to understand what the future may hold for Twitter. Financial metrics such as revenue, earnings, and cash flows are undeniably important. However, user metrics are absolutely crucial for investors in Twitter stock.
It's all about users
The social media industry is a textbook example of an industry operating under the network effect. This means that the value of the service increases as it has more users, which provides a self-sustaining growth driver for market leaders in the business.
Having a Twitter account doesn't make much sense if no one else is using the platform. However, if the network provides an opportunity to follow all kinds of interesting accounts and interact with them, the incentives to join are much stronger. This means that users attract each other to the leading social media platforms, and the bigger the platform, the more valuable the service it provides to such users.
The size of the user base says a lot about the company's competitive strength and staying power, and it also has big implications from a financial perspective. If Twitter is going to produce growing revenue and earnings over time, then it needs a dynamic and actively engaged user base in order to generate more business opportunities in online advertising and data licensing.
Twitter is underperforming where it counts
The company ended the second quarter of 2016 with 313 million monthly active users around the world, a modest increase of 3% versus the second quarter in 2015. The user base in the U.S. reached 66 million, growing by 1% year over year. In international markets, the platform has 247 million monthly users, and the user base expanded 4% during the quarter.
The number just pales in comparison to Facebook (NASDAQ:FB). The social network founded by Mark Zuckerberg has 1.71 billion monthly active users as of the second quarter of 2016, growing by 15% against the same quarter last year. Adding insult to injury, Facebook is vigorously expanding into new platforms such as Instagram, Messenger, and WhatsApp, and the company is also leaving Twitter in the dust in these younger segments. Instagram has over 500 million monthly active users and 300 million daily active accounts, while Messenger and WhatsApp both have more than 1 billion registered accounts each.
Twitter does not officially disclose daily active users, but some analysts are estimating that Snapchat could also be bigger than Twitter when it comes to daily users. According to an article by Bloomberg Technology, Snapchat is estimated to have nearly 150 million daily users versus 136 million daily users for Twitter.
Twitter is delivering well below its potential when it comes to such an important aspect as users. The company comes substantially behind Facebook, and emerging competitors like Snapchat are becoming an increasingly important threat in this area. This is arguably the main reason why Twitter stock is doing so bad lately.
Can Twitter jump-start growth?
The good news is that Twitter stock offers abundant upside potential from current prices if the company can jump-start user growth, and Twitter has many important advantages in the business. Many personalities and celebrities use Twitter regularly, and this naturally works as a magnet for both current and potential users. The short-message format is especially suitable for smaller screens in mobile devices, and Twitter is particularly strong when it comes to real-time news coverage.
Management is implementing multiple initiatives to gain traction among users. Among other things, Twitter is increasing its focus on video and images content, and the company has recently signed an agreement with the NFL to stream 10 NFL Thursday Night Football games during the 2016 season. If this agreement turns out to be successful, it could open the door to promising streaming opportunities in the future.
It's easy to see how Twitter could do substantially better on the user front. Above all, the company needs to make the user experience simpler and easier to enjoy. Unfortunately, this is easier said than done, and implementation is absolutely key. Until management proves to investors that it has a viable strategy to drive sustained user growth, shares of Twitter will probably remain under heavy pressure.
Andrés Cardenal has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Facebook and Twitter. 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.