Twitter Pic

Image source: Twitter.

Twitter (NYSE: TWTR) stock has been pulverized lately: Shares of the short-message social network are down by a breathtaking 50% from their highs of the last year. Even after this huge decline, Twitter still carries a short interest ratio in the neighborhood of 11% of the float, meaning that many investors are still heavily betting that Twitter will continue on its downward spiral.

However, the bears in Twitter stock could be making an expensive mistake. While the company is facing important challenges, there are strong reasons to believe that Twitter could deliver powerful gains from current levels.

Twitter's big problem
Twitter's main problem is disappointing user growth. The company ended the third quarter of 2015 with 320 million monthly users, an increase of 11% versus the same quarter in 2014. Excluding SMS Fast Followers, Twitter has 307 million monthly users, an increase of only 8% year over year.

Twitter pales in comparison to Facebook (NASDAQ:FB) and its gargantuan user base of 1.55 billion monthly users as of the third quarter. All else equal, a bigger platform should theoretically grow at a slower rate, since it's harder to sustain rapid growth from a larger base. However, Facebook still reported a big annual increase of 14% in its monthly user base last quarter.  

Even LinkedIn (NYSE:LNKD), which is specifically targeted toward job opportunities and professional contacts, is doing better than Twitter on the user front. LinkedIn ended the third quarter with 396 million cumulative members, a year-over-year increase of 20%. Twitter has a broader potential audience than LinkedIn, but this is not being reflected on user growth metrics for both platforms.

Attractive valuation
While Twitter is clearly underperforming when it comes to user growth, management is doing a sound job on monetization. This allowed the company to deliver a big increase in revenue of 58% last quarter. In fact, Twitter is outgrowing both Facebook and LinkedIn in terms of sales: Facebook's revenue grew 41%, while LinkedIn reported a 37% increase in revenue during the third quarter.

However, when comparing Twitter against Facebook and LinkedIn in terms of market capitalization or price-to-sales ratio, Twitter is priced at a substantial discount versus its peers. 

CompanyMarket Cap Price to SalesPrice to Book ValueForward P/E 
Facebook $298.2 billion 19 37
LinkedIn $32.1 billion 12 7 66
Twitter $17.6 billion 9 4 44

Data sources: SEC filings and FinViz. 

Disappointing user growth is already reflected on Twitter's valuation to a good degree, and the stock could rise materially from current levels if management can accelerate growth in the middle term.

Chances for a turnaround
To begin with, Twitter is here to stay: The platform is well beyond the inflection point in terms of  proving its relevance. Many political leaders, movie stars, renowned athletes and all kinds of important personalities have chosen Twitter as the best platform to directly communicate with a wide global audience. Twitter clearly comes behind Facebook in terms of size, but the company has a major advantage when it comes to the quality and importance of the interactions. 

Many websites, newspapers, and even the TV generally cover what is going on in Twitter. This says a lot about the platform's significance, and management is also exploring ways to monetize the massive amounts of traffic coming from these external sources. 

The company is also working on different kinds of initiatives to jump-start user growth. Moments is big bet in this area, aimed at providing a simpler and more enjoyable experience to users. The Moments tab shows a collection of the day's top stories, curated and organized by Twitter's editorial team and by a select group of partners such as Buzzfeed, NASA, and the New York Times, among several others.

In addition, Twitter is expanding its capabilities in photos and video. The company bought the popular video app Vine in February of 2015, and its Periscope live streaming service has gained considerable traction among users. According to management, native video consumption across Twitter, Vine, and Periscope is up by a staggering 150 times in the last six months.

These are just a few relevant examples of the kinds of strategies management is exploring to sustain sales growth and attract more users to the platform. The main point is that Twitter has a lot of room for improvement in this area, and the stock offers far more upside potential than downside risk at current levels.

Andrés Cardenal owns shares of LinkedIn. The Motley Fool owns shares of and recommends 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.