Shares of social network platform Twitter (TWTR) exploded higher on Monday, rising about 30%. The big move came as Tesla (TSLA 0.95%) and SpaceX founder Elon Musk revealed he had established a 9.2% stake in the company. Clearly, some investors believe that Elon Musk's interest in the tech stock is good news for its long-term potential. But instead of betting on the stock simply because Elon is buying shares, let's take a closer look at the company's fundamentals relative to its stock price to see if shares really do look attractive or not.
Twitter's strong top-line momentum
In Twitter's fourth quarter, revenue grew 22% year over year. Management said in the company's Q4 letter to shareholders that this growth was helped by "ongoing revenue product improvements, solid sales execution, and a broad, continued increase in advertiser demand."
Of course, the company's growth in monetizable daily active users is fundamental to this growth. Without a strong and healthy user base, advertisers wouldn't be very interested in the platform. To this end, Twitter's monetizable daily active users increased 13% year over year in Q4, hitting 217 million. This user growth, management said, was aided by a combination of product improvements and conversations on the platform regarding current and global events.
Importantly, management expects this robust top-line growth to continue in 2022. Management guided for revenue this year to increase at a rate in the low- to mid-20% range when excluding revenue from the MoPub assets it divested and winded down from 2021 financials.
There's no surefire way to peg a valuation of a stock with any certainty. But in one approach that can perhaps get us in the ballpark of what the company is worth, we could take Twitter's 12% net profit margin from Q4 and apply it to analysts' consensus forecast for 2022 revenue of $5.9 billion in revenue to estimate the company's potential profits, and then apply a valuation multiple to these theoretical earnings. This math would translate to $708 million in 2022 net income. Notably, however, the company's plans to reinvest in growth opportunities will likely prevent Twitter from actually achieving net income this high in 2022. But this exercise helps demonstrate what earnings could look like if it was management's priority to maximize profits today. Wrapping up this valuation, if Twitter were to trade at 40 times these hypothetical earnings levels (an ideal multiple for a fast-growing tech company with likely margin expansion over the next decade), this would put the fair value of Twitter's market cap at $28 billion -- a level the company was notably trading at earlier this month.
Unfortunately, Elon Musk's interest in the stock has sparked a lot of incremental investment from Wall Street, and the company now has a $41 billion market capitalization. While its rerated valuation post-Elon Musk investment doesn't seem wildly expensive, it does make the stock too pricey to call a buy at this level.
To be fair, this surface-level approach to valuing Twitter stock could be too conservative. After all, Meta Platforms has garnered a net profit margin higher than 30% in recent years. If Twitter's net profit margin expands to similar levels over time, and if revenue continues to grow rapidly, even a $41 billion market cap may represent a respectable entry point into the stock. But for now, investors may want to consider staying on the sidelines and hoping the Elon Musk premium on shares dissipates.