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The Twitter Dilemma

By Daniel Segundo - Jan 27, 2014 at 10:50PM

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Is Twitter overvalued at current levels?

Twitter (TWTR -0.30%) is a service that allows users to share whatever is on their minds. Although the service is pretty straightforward, an investment in the company is a bit different. The company has recently been barraged by a number of institutions, each placing long or short bets on the company's prospects. In response, many investors have been aggressively buying or selling. This has resulted in a lot of of volatility for the new company, and as a result, many investors have begun to question Twitter's true value. The question that remains is whether Twitter is deserving of its current valuation, and whether the company will face a fate similar to Facebook's (META -0.11%).

What is Twitter currently worth?
Twitter's current valuation appears questionable. The company isn't profitable yet, and it's already trading upward of 61 times sales. Twitter is a major beneficiary of the network effect, and it's large platform of users has contributed to the service becoming more valuable as more people use it. In addition, Twitter's scale as a social media network has created a relative moat. Like many firms that benefit from the network effect, Twitter's moat has an expanding trend. Needless to say, Twitter definitely has a strong competitive position in the social media atmosphere, however, even the best moat can't possibly enrich shareholder value if it comes at an outrageous price. Compare Twitter to rivals Facebook and LinkedIn (LNKD.DL), which both trade at 20 times sales. Both of these companies benefit from the network effect and have wide, expanding moats as well, but their valuations are one-third Twitter's. In addition, both of these companies have been monetized to a respectable degree, while Twitter still needs to prove itself.

Similar to how Facebook was valued during its IPO, Twitter seems to have a valuation nearly priced for perfection. Therefore, the market has been expecting still results out of Twitter from very early on, and even though these results may come down the road, Twitter must find an effective monetization strategy. Twitter's current valuation would seem to suggest that the company has already been monetized to a large degree, but this just isn't the case. Twitter may likely find itself in the same shoes that Facebook was in during it's first couple of years as a public company -- a grossly overvalued stock with minimal appreciation potential, that eventually became an unloved and undervalued opportunity. 

The bottom line
The reality is that Twitter is currently trading at a very lofty valuation. Perhaps the market didn't learn from Facebook's IPO, but the amount of speculative money being dumped into Twitter is quite massive, as shares of the company have nearly doubled since its IPO. Even if you don't short Twitter at current levels, you should certainly avoid buying, in light of its expensive price. If you are more aggressive, shorting the company might not be such a bad idea, since it is likely that the company will come back to Earth and fall to more of a realistic valuation. But at the end of the day, the company has a wide, expanding moat, profitability is likely to continue, but this depends upon management's ability to monetize. Undoubtedly, Twitter may present a great opportunity to aspiring investors down the road if it reaches a cheaper valuation. For now, however, the company is simply another case of a strong moat trading at a ludicrous price.

Fool contributor Daniel Segundo has no position in any stocks mentioned. The Motley Fool recommends Facebook, LinkedIn, and Twitter. The Motley Fool 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.

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Stocks Mentioned

LinkedIn Corporation Stock Quote
LinkedIn Corporation
Meta Platforms, Inc. Stock Quote
Meta Platforms, Inc.
$174.66 (-0.11%) $0.19
Twitter, Inc. Stock Quote
Twitter, Inc.
$43.86 (-0.30%) $0.13

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