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Below Its IPO Price, Is Twitter, Inc. Stock a Buy?

By Daniel Sparks – Aug 26, 2015 at 4:10PM

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Even after a sell-off, it's still difficult to justify buying Twitter stock.

Twitter (TWTR) stock has been absolutely hammered this year. After rising to $53 earlier this year, shares have since been halved. Now trading at around $24, Twitter stock's year-to-date return is a disappointing -32%. The recent market sell-off, which particularly affected high growth stocks like Twitter, has sent shares 14% lower in the past five days alone. But it is possible that the market has been too pessimistic about the company's future and actually oversold shares?

Twitter headquarters. Image source: Twitter

Valuing Twitter
It's difficult to value high growth companies, let alone ones that haven't yet reported a profit. But to gain at least some perspective, let's resort to comparison -- a more useful practice now that Twitter's high-flying peers have been subject to their own haircut during this market correction. What better comparisons than publicly traded social stocks Facebook (META 7.89%) and LinkedIn (LNKD.DL)?

Company

Price-to-Sales

Price-to-Gross Profit

Twitter

9.3

13.7

Facebook

17.2

19.3

LinkedIn

8.4

10

Given that the two have similar digital-advertising dependent business models and could likely manage their businesses with similar operating margins at a steady, slower-growth state at some point in the future, their price-to-sales and price-to-gross profit comparisons, side by side, provide somewhat useful perspective about the sentiment for each company's relative potential. Given Facebook's higher premium to sales and gross profit than Twitter's, it's clear that the market has higher expectations for Facebook, going forward.

But since LinkedIn's business model is quite different than Twitter's and Facebook's, with advertising only representing 20% of revenue, a side-by-side comparison with digital-ad dependent social stocks like these two should be taken with a grain of salt. That said, it's still useful to acknowledge that there is another major online social network trading at a lower premium to sales and gross profit than Twitter.

Going a bit further, with the above valuation ratios in mind, consider a side-by-side comparison of these companies' recent revenue growth.

Company

YoY Revenue Growth, Latest Quarter

YoY Revenue Growth, 2014

YoY Revenue Growth, 2013

Twitter

61%

111%

110%

Facebook

39%

58%

55%

LinkedIn

33%

45%

57%

Investors might wonder, with Twitter's advertising revenue growing significantly faster than its peers, shouldn't investors be more optimistic about its growth potential than Facebook's and reward the stock with a higher premium? Further, given Twitter's much higher growth than LinkedIn's recently, shouldn't Twitter's premium to sales and gross profit be further ahead of LinkedIn's than it is? Not necessarily. The primary reason for the skepticism toward Twitter today is the company's inability to grow its user base at meaningful rates in recent quarter -- and the concern is merited. After all, if Twitter is already approaching its peak in users, investors will be reluctant to believe the company can continue to increase advertising revenue as rapidly as it is.

Putting it as simply as possible, Twitter stock isn't looking cheap yet. Sure, management may turn the company's user growth problem around and digital advertising revenue growth may continue at meaningful rates for years to come. But until Twitter can prove to investors it has a working strategy for attracting and retaining a larger number of new users, it may be worth waiting to see if the stock sells off even further.

On the flipside, just because Twitter stock isn't a clear buy today doesn't mean it's automatically a sell. But current shareholders should definitely keep an eye out for a viable turnaround strategy regarding user growth.

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

Twitter Stock Quote
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LinkedIn Corporation Stock Quote
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