U.S. stocks are recouping part of yesterday's losses; perhaps investors are heartened that Chinese stocks posted only a small loss on Tuesday. The Dow Jones Industrial Average (DJINDICES:^DJI) and the broader S&P 500 (SNPINDEX:^GSPC) are up 0.76% and 0.93%, respectively, at 12 p.m. EDT. The Nasdaq Composite was up 0.69%. Shares of micro-blogging platform Twitter (NYSE:TWTR) are outperforming in the run-up to this afternoon's earnings report in a key week for social networking stocks -- both Facebook (NASDAQ:FB) and LinkedIn (NYSE:LNKD.DL) will report on Thursday.
During Twitter's short life as a public company, the stock's valuation, the high growth expectations embedded in it, and the uncertainty that characterize those expectations have repeatedly caused substantial volatility in the share price following earnings announcements. The average size of the shares' one-day reaction (up or down) over the past six quarters is 16.2%! This could easily happen again during today's after-hours session and tomorrow.
Indeed, Twitter's valuation still looks inflated to me. The consensus estimate for 2017 earnings per share is $1.18, according to data from Bloomberg. At yesterday's closing price of $34.70, the shares are thus valued at 29 times the estimate for 2017.
While that multiple isn't completely absurd for a growth company, it's based on a consensus estimate that assumes superlative performance over the next two and a half years. Indeed, in order for Twitter to hit that $1.18 estimate for 2017, it will need to (roughly) double annual earnings per share for three years consecutively -- heady growth expectations.
Let's not forget that the 2017 estimate represents adjusted earnings per share rather than an earnings figure that conforms to GAAP [Generally Accepted Accounting Principles], which is stricter. On a GAAP basis, analysts don't expect Twitter to be profitable until 2018.
While the shares are not as expensive as they have been at certain points in the past, I think odds are good that we'll witness a significant price move tomorrow in reaction to this afternoon's results (furthermore, I think the odds are skewed toward a downward move -- but that may simply reflect this value investor's bias).
Finally, as long as Wall Street is fixated on user growth, particularly in comparison with Facebook, the potential for disappointment is there. I've written time and again that the two are different animals, and that Twitter will never become a mainstream application comparable to what its larger rival has already achieved -- the "grammar" of tweets and structure of the network guarantee this.
Twitter's management (and its investors) would be better off accepting that fact now, which would enable them to focus on the application's core attributes and monetizing the (genuine) value it presents. That's one more reason Twitter's board would do well to quickly find a permanent replacement for Twitter's current interim CEO and co-founder Jack Dorsey. A fresh perspective and full-time focus -- Mr. Dorsey is simultaneously the CEO of mobile payments company Square -- are vital at this stage.
Alex Dumortier, CFA, has no position in any stocks mentioned. The Motley Fool recommends Facebook, LinkedIn, and Twitter. The Motley Fool owns shares of Facebook, LinkedIn, 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.