Although we don't believe in timing the market or panicking over daily movements, we do like to keep an eye on market changes -- just in case they're material to our investing thesis.
Stocks rose smartly today, with the S&P 500 and the narrower, price-weighted Dow Jones Industrial Average (DJINDICES:^DJI) up 0.4% and 0.8%.
Twitter and its bankers set the price for its shares at $26 in the most anticipated IPO since Facebook (NASDAQ:FB) went public in May 2012. That figure values the microblogging company at nearly $18 billion; assuming the underwriters take up the overallotment option on 10.5 million shares in addition to the 70 million shares being sold, the company will raise approximately $2 billion.
Not coincidentally, shares of Facebook and LinkedIn (NYSE:LNKD.DL) declined by 2% and 1.7%, respectively, today -- substantially underperforming the broad market. Why would Twitter's launch hurt Facebook and LinkedIn shares on a short-term basis? Investors wishing to broaden their exposure to the social networking sector are likely reducing their existing positions in the latter to make way for Twitter in their portfolio.
The two companies are arguably Twitter's closest comparable companies in terms of visibility and their association with the concept of social networking. (However, while Facebook's advertising-focused business model is similar to Twitter's, LinkedIn has a different, more robust revenue model that includes charging premium members and companies for their services.)
With an implied market value of nearly $18 billion, Twitter is much smaller than Facebook ($120.6 billion), but it's within striking distance of LinkedIn, at $26.4 billion. That comparison ought to give investors pause, as it highlights the sort of expectations that are fueling Twitter's valuation (not to mention the fact that the stock may experience a significant "pop" as it hits the secondary market tomorrow). Consider and combine the following observations:
- At 113 times estimated earnings per share for the next 12 months, LinkedIn's shares already look very expensive indeed.
- LinkedIn's trailing 12 months' revenue of $1.38 billion is more than two-and-a-half times Twitter's.
- LinkedIn is profitable and was already turning a profit prior to its IPO; the same can't be said for Twitter. In fact, analysts don't currently expect Twitter to turn a profit next year, either -- their consensus forecast calls for a $0.04 loss in 2014.
- Finally, although Twitter may be growing faster than LinkedIn at this time, its business model is not mature; in fact, it could probably be described as largely experimental. Meanwhile, LinkedIn has a very powerful, stable business model that doesn't rely on untested forms of advertising.
I'm not against investing in growth stocks -- or even in nickel mines in Canada -- as long as people understand what they're investing in and the associated risks. Twitter has already had a very significant impact on the media/ communications landscape and on popular culture, but, as a business, it remains largely unproven. Confusing societal impact and business success is a dangerous mistake, but Twitter's valuation suggests investors participating in the IPO have done just that – either that or they are counting on a "greater fool." Don't let that greater fool be you.
Editor's note: A previous version of this article gave an incorrect market capitalization for LinkedIn. The Motley Fool regrets the error.
Fool contributor Alex Dumortier, CFA has no position in any stocks mentioned; you can follow him on Twitter @longrunreturns. The Motley Fool recommends and owns shares of Facebook and LinkedIn. 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.