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3 Ways to Value Twitter Today

By Chad Henage – Mar 27, 2014 at 8:00PM

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To understand Twitter's valuation, investors need to look beyond traditional measures like the P/E ratio.

Depending on who you ask, Twitter (TWTR) is either a tool to get real-time updates on your favorite subjects and people, or it's an incomprehensible social media site. The ironic thing is, Twitter might be the best tool for news delivery that millions of people have never used. To try and solve the question of what this business is worth, let's look at three ways investors might value the stock.

Value per user
If a bigger audience means greater opportunity for growth and monetization, then in theory, Facebook's (META -0.40%) user base should be worth more than either Google's (GOOGL -0.83%) Google+ or Twitter. With a market cap of over $165 billion and 1.2 billion active monthly users, Facebook carries about $140 of market cap per user.

By comparison, Google+ is a real challenge to value. If Google's market cap was based just on this service alone, Google+'s 300 million users would work out to a value of over $1,300 in market cap per user. Obviously, Google is far more than just Google+. A better comparison might be YouTube's 1 billion users, in which case Google gets about $400 in market cap per user.

Twitter, on the other hand, has a market cap of about $27 billion, and with 241 million monthly active users, this works out to about $112 in market cap per user. Compared to Google, Twitter users are valued far less. However, in comparison to Facebook users, Twitter users are only valued 20% lower.

Though Facebook has about 400% more monthly users than Twitter, Facebook's stock value is 500% higher. This disconnect between users and market cap could mean an opportunity for Twitter investors.

Price to sales
A core belief among growth investors is that the traditional P/E ratio doesn't work as well as price-to-sales. In theory, a growth stock is plowing extra cash into expansion and not generating earnings. However, as the company reaches scale and these expenses slow down, earnings will explode and catch up to the stock price.

Using the price-to-sales ratio, the comparison is staggeringly simple. Twitter's price-to-sales ratio is over 40, Facebook's is over 20, and Google's is 7. While it's true that Twitter and Facebook are expected to grow revenue much faster than Google, the difference in valuation is hard to ignore.

It is possible Twitter will grow revenue by double the amount of Facebook. In the current quarter, Twitter's revenue jumped 116%, compared to a 68% increase at Facebook. However, Twitter needs to make sure it fires on all cylinders to make this valuation worthwhile for investors.

Cash Flow
Though huge cash flow isn't expected from many fast-growing companies, a path to free cash flow is always nice to see. Comparing how much free cash flow a company can generate from each dollar of sales may give investors a clue to which company is more efficient.

Google is far more established than either Facebook or Twitter when it comes to cash flow generation. In the current quarter, the company generated about $0.20 of core free cash flow for every dollar of sales.

Considering Facebook's torrid growth, the company's $0.12 of core free cash flow per dollar of sales is very impressive. Where Twitter is concerned, we have to strip away the company's significant stock compensation expenses to find a path to free cash flow. On this non-GAAP basis, Twitter actually produced about $0.06 of core free cash flow. Of course, for this to be a sustainable figure, Twitter will need to find a way to quell its significant stock compensation expenses.

If Twitter can get past this initial phase as a publically traded company, it's hard not to notice the potential. On a non-GAAP basis, Twitter produced about half as much free cash flow as Facebook and 70% less than Google. However, the company's business model hasn't been centered on monetization, and Twitter has far fewer users to monetize than either of its peers.

The point
Twitter is a great real-time news feed for those who know how to use it, and the market seems to understand the opportunity. As more users find their way to Twitter, the company can expand the currently limited profile to gain more information for advertising. The limitation on the length of tweets forces users to focus on what they want to say, which should be easier to mine for useful data as well.

Twitter is a great way to get real-time socially sourced news. This is the company's competitive advantage and advertisers should realize this value over time. That is where Twitter is @, and adding TWTR to your Watchlist is just one way to keep up with this #opportunity.

Chad Henage has no position in any stocks mentioned. The Motley Fool recommends Facebook, Google, and Twitter. The Motley Fool owns shares of Facebook and Google. 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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