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As Sentiment Shifts, What Happens to Facebook and Twitter?

By Alex Dumortier, CFA – Jul 8, 2014 at 7:00PM

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Facebook and Twitter shares take a drubbing, but one is a better value than the other.

U.S. stocks notched up their second straight day of losses on Tuesday, with the benchmark S&P 500 and the narrower Dow Jones Industrial Average (^DJI 1.26%) both declining 0.7%. The technology-heavy Nasdaq Composite Index (^IXIC 1.74%) was down 1.3%.

Registering some of the largest declines on Tuesday were two high-profile growth stocks: Facebook (META 1.97%) (-3.9%) and Twitter (TWTR) (-7%). However, it looks like those drops were symptomatic of a broader punishment meted out by investors against growth momentum names. Where does that leave the shares of the two competing social networks?

The dramatic decline in asset price volatility has not gone unnoticed, including in this column, but the market isn't monolithic. Look around you and you'll find pockets of volatility, or as Bespoke Investment Group remarked this morning in a tweet:

Momentum names acting like they did in March and April last two days. Definitely going to hit sentiment hard.

— Bespoke (@bespokeinvest) July 8, 2014

"Sentiment" is the key term here. Financial journalists and pundits always bend over backwards to explain stock price movements, even when the underlying reason is not much more profound or instructive than "more buying than selling" (or vice versa.) With regard to Twitter's fall, for example, TechCrunch pointed to another executive shuffle, but it's unlikely that would have accounted for anything more than a fraction of the 7% stock price decline.

Speaking on CNBC, a SunTrust Robinson Humphrey Internet equity analyst identified a more likely culprit: a highly anticipated research report published late yesterday with a monthly active user estimate for Twitter that was lower than the current consensus estimate of 266 million. (The organization that produced the report had -- either through luck or talent -- produced a very accurate estimate one quarter ago.)

But if we use Facebook's nearly 4% decline as a proxy -- I could find no story of any real significance affecting Facebook today -- the disappointing report on Twitter would account for less than half the drop in its stock. The simple truth is that, given its valuation and its "investor" base, Twitter is at the sharp end of the spear when it comes to shifts in investor sentiment, whether they are stock-specific or whether they affect a broad swath of momentum names, such as the one we appear to have witnessed over the past two days.

Even after today's drop, Twitter's stock looks far from cheap, at 144 times next year's earnings-per-share estimate of $0.26. Make no mistake about it: Twitter looks like it could develop into a decent business, but at its current valuation, the stock remains a highly speculative operation. Facebook shares, on the other hand, are now valued at a relatively pedestrian 34 times next year's estimated earnings per share; if the current downdraft in momentum names continues, they could soon approach fair value. A more dominant franchise at a better valuation -- that's not a difficult choice, in my book.

Alex Dumortier, CFA, has no position in any stocks mentioned. The Motley Fool recommends Facebook, Tesla Motors, and Twitter and owns shares of Facebook and Tesla Motors. We Fools don't 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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