No One Knows Why Twitter Popped -- but Here's What Matters

Source: Twitter

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.

On the back of their first losing week in over than two months, stocks rose to a new record high on Monday, as the S&P 500 gained 0.2%. The narrower, price-weighted Dow Jones Industrial Average (^DJI -0.85%) was essentially unchanged, gaining just three-hundredths of a percentage point.

Meanwhile, shares of Twitter (TWTR) enjoyed their best day since the microblogging platform went public on Nov. 7, rising 9.3%, to close at a record high of $49.14. It's not entirely clear why the pop occurred today, as there was no significant breaking news relating to the company.

Never willing to admit ignorance, the financial media is attributing the price action to a favorable reception by investors of new tools to improve the effectiveness of Twitter ads -- tools that were released last week. Last Thursday, Twitter began allowing marketers to serve individually targeted ads based on users' web browsing history; known as cookie-based targeted ads, they are expected to command higher ad rates.

Instead of bending over backwards trying to explain today's price action, let's consider what it means for the shares' valuation and shareholders' future prospects. As the following tables shows, Twitter is now significantly more expensive, based on multiples of projected revenue, or EBITDA (earnings before interest, taxes, depreciation and amortization -- a measure of cash flow), than the two other major social networking companies Facebook (META -10.24%) or LinkedIn. Not to mention that Facebook and LinkedIn are aggressive benchmarks, as those stocks can hardly be considered cheap themselves!

*EBITDA, or earnings before interest, taxes, depreciation and amortization, is a measure of cash flow. Source: Capital IQ.

Twitter proponents will argue that, with $534 million in revenue over the 12-month period to Sep. 30 (to Facebook's $6.9 billion), the company has a lot more room to grow. However, as Deutsche Bank's Ross Sandler pointed out in his initial note on the stock, published last Monday, "the biggest unknown is that TWTR may be a niche product and won't break through to the mainstream, and may never see MAUs [monthly active users] up near the 1B[illion]+ levels of megaplatforms like GOOG and FB."

Twitter's current valuation doesn't leave much room for that unknown; instead, it suggests that investors believe that achieving "megaplatform" status is virtually certain.

Digital media, including social media, is transforming the advertising business, and taking market share from traditional media. Zenith Optimedia, a unit of advertising major Publicis, just released forecasts according to which television's share of the global ad market peaked this year after three decades of growth, whereas they expect mobile advertising to grow at an annualized rate of 50% between 2013 and 2016.

Those are the sort of projections that get growth investors salivating; but, as they push Twitter's shares higher, they ought to remember that Twitter's mainstream acceptance is not a foregone conclusion. Last October, for example, the Financial Times spoke to several advertising executives at major firms who said that ad spending on Twitter currently comes out of "experimental budgets." That doesn't sound like a mainstream platform – not yet, anyway.