Twitter (NYSE:TWTR) is a social media platform that just about everybody is familiar with at this point. It's popular, it's cool, and it's apparently causing investors to go a little bit nutty. While "don't fight the tape" is a common axiom, particularly among more short-term oriented traders, long-term investors should be scared out of their wits when they peel back the hype surrounding the market's latest social-media darling and actually examine the financials. Twitter's valuation is, by all counts, absolutely absurd and long-term investors should be incredibly wary of buying shares here.
Doesn't this sound ridiculous?
Imagine if somebody told you that they've got a business that they'd like to sell you. This business is on track to generate $639 million this year and lose about $0.18 per share. Now, this is a sizzling hot growth story and investors are expecting that the company will grow sales to a "whopping" $1.13 billion next year, and only lose $0.04 per share. So, how much do you want to pay for this business? Well, it's a hot growth story just like Facebook (NASDAQ:FB), the world's leading social media site, so maybe you're willing to pay 13 times forward revenue consensus (which is where Facebook trades). This would suggest a market capitalization of $14.69 billion.
But hey, Facebook is old news and Twitter is the new thing in town, right? So, let's go hog wild and suppose that it should command twice the valuation on a forward price-to-sales basis. At 26 times forward revenue estimates (again, we are being exceptionally generous here), Twitter would be worth about $29 billion, implying a share price of $52. So, what are the shares trading at today? Would you believe over $68 per share as of the time of writing?
Why Twitter keeps going up
The question that long term investors need to ask is whether they would (if they could) buy the entire company. It's unlikely that the majority of people trading shares of Twitter (or Facebook, for that matter) would actually choose Twitter out of all the businesses that $40 billion could buy. What's going on here is that momentum traders (i.e., people who buy because the stock is going up and short because the stock is going down) are having a field day with this stock. It trades on news flow and hype, and the stock is going to be extremely volatile as both the longs and the shorts duke it out.
Foolish bottom line
Social media today seems awfully like a remix of the 1999-2000 bubble, where anything and everything related to the Internet would, right out of the gate, trade massively up from the offering prices. Now, this isn't as extreme, as many of the newly public companies back in the day barely had any revenue (if they had any at all). Further, the mania back then was so widespread that many folks were quitting their day jobs to day trade tech and telecom stocks. Some made fortunes, but others lost it all.
Twitter may or may not end up being a compelling growth story, but with a roughly $40 billion market capitalization, the opportunity seems to be priced in multiple times over. While some might argue that since Facebook is "worth " $140 billion that Twitter can get there, too, but that argument is dubious at best since it is highly predicated on Facebook -- which is also extremely expensive -- turning out to be anywhere close to fairly valued (something that isn't at all clear at this point).
Ashraf Eassa has no position in any stocks mentioned. The Motley Fool recommends Facebook and Twitter. The Motley Fool owns shares of Facebook. 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.