Stop me if you've heard this before: Twitter (NYSE:TWTR), though it has a great product and tons of potential, is fundamentally broken -- and investors would be wise to stay away from this stock in 2015.
There are many reasons to be cautious when it comes to Twitter stock, most notably slowing growth of monthly active users. But I think that with the right adjustments, Twitter can right its ship in short order and investors could easily one day consider today's $37 price tag a steal. Here's why.
Slowing growth is a problem, but...
When Twitter announced third-quarter earnings in late October, investors focused intensely on growth in monthly active users, or MAUs. Both at home and abroad, the trends were not encouraging.
Growth has always been slower in the United States than in foreign markets. But the somewhat dramatic slowdown in international MAUs -- which account for 78% of all Twitter users -- caught many off guard.
There has been much finger-pointing regarding the cause of the slowdown, but my own understanding of the problem is somewhat simple.
Twitter's interface and platform -- both desktop and mobile -- aren't as intuitive as social-media rival Facebook's (NASDAQ:FB). It can also be tough for new users to build a following, if that's what they're interested in, which, given the metric's front-and-center display on anyone's profile, the company makes important.
A Deutsche Bank analysis showed that 60% of the users who leave Twitter have fewer than 10 followers while those who have more than 100 followers account for just 5% of those leaving the service. That's a serious long-term problem.
At a Twitter analyst meeting in November, management set out to let investors know how it intends to fix this situation. First, the sign-up process is being simplified: It is focusing on educating new users about how Twitter works (maybe it should just show this clip from The Tonight Show Starring Jimmy Fallon) and helping new users gain followers right off the bat.
At the same time, Twitter has increased research and development expenses from just $119 million in 2012 to $905 million over the last 12 months -- a 660% increase. I trust that much of that will go toward improving the user experience.
More importantly, the company's Fabric software development kit is allowing many developers to build new apps and products using the data that Twitter has collected. This will make the value of Twitter's database even more lucrative.
The migration of advertising dollars to digital outlets
It's kind of hard to believe, but most companies still devote the vast majority of their advertising dollars to TV, print, and radio. In 2012, those three gobbled up 69% of all advertising dollars spent.
It won't be that way for long. Here's how eMarketer sees the space maturing between 2012 and 2018. Pay close attention to the slice highest on the chart: mobile advertising.
For investors in social-media companies such as Twitter and Facebook, there is perhaps no chart more crucial to a successful investing thesis than this one. Between 2012 and 2018, advertising spending on all other forms of media except mobile is expected to be flat. Virtually every extra dollar that is poured into advertising is expected to go to mobile.
To put this in perspective, $4.3 billion was spent on mobile advertising in 2012. By 2018, that number is expected to balloon to $58.2 billion. That's an annualized growth rate of 55%!
Already, Twitter has proven it can rapidly increase its advertising coffers. In 2011, the company recorded ad revenue of $78 million. Over the last 12 months alone, that figure has grown to $1.04 billion -- an increase of over 1,200% in less than three years.
That helps explain why -- even though it isn't profitable -- Twitter stock carries a roughly $37 price tag, valuing the company at around $22 billion. There's no doubt that with such a market cap, there's risk involved for investors.
However, that lack of profitability is because Twitter is aggressively reinvesting in itself. From a simple price-to-sales ratio, Twitter is valued on par with Facebook, at 19 times sales. But Twitter is growing its revenue base far quicker than Facebook over the past three years: 139% versus 65% per year, respectively.
I think Twitter could easily be worth between $75 and $100 million five years from now -- if it can execute its plan.
Combine this with the potential for Fabric to make Twitter's data even more valuable, and you can see why I'm willing to give the company a pass -- for now -- on its slowing MAUs and not-so-intuitive interface. The company knows it needs to fix these problems, and as a shareholder I'll be willing to wait and see what happens.
Brian Stoffel owns shares of Facebook. The Motley Fool recommends Facebook and Twitter. The Motley Fool owns shares of Facebook and Twitter. 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.