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Is Twitter Stock a Buy After Its Post-IPO Run-up?

The company's first earnings report since going public could shed light on whether the richly priced shares are worth it.

As Twitter (symbol TWTR) was about to make its highly anticipated market debut on November 7, we stuck to our philosophy on initial public offerings: Wait at least 90 days before buying. Why? To allow the hype to die down and rational analysis to take over. It seems, however, that 90 days may not be long enough.

 

At its high point during nearly three months of trading, Twitter stock almost tripled from its $26 IPO price. Even after a pullback of more than 10%, to $65.25, it easily exceeds the 12-month target prices of even many bullish analysts. (Share prices and related figures are as of February 3 unless otherwise noted.)

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Few doubt that Twitter, which has more than 230 million users, is already a big thing. But the financial projections required to justify today's share price call for it to become a really, really big thing — really fast.

As such, investors are being asked to pay a bundle for Twitter's potential. Since the company is nowhere close to profitability, the shares must be valued on a multiple of sales, or on analysts' forecasts of distant earnings, some for 2015 or later. When 2013 results are released on February 5, analysts expect Twitter to report sales for the year of $639 million and a loss of 19 cents per share.

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At $59 per share, its price until a recent runup ahead of the earnings release, Twitter traded at 23 times analysts' consensus estimate of 2015 revenue, says SunTrust Robinson Humphrey analyst Robert S. Peck. That's 125 times the consensus for EBITDA, an alternative profit measure that leaves out interest expenses, taxes, depreciation and amortization charges. By comparison, Peck says, other fast-growing Internet companies average eight times 2015 sales and 24 times their 2015 estimated EBITDA.

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For an investor to receive a 20% annual return on Twitter stock (or $101 per share) at the end of 2016, Peck says, the company must grow to $4 billion in revenue by 2017, and the market must still be willing to pay 17 times sales — twice the industry multiple. "While those estimates may be achievable, we don't feel comfortable being that aggressive yet," Peck says.

Aggressive might be the watchword for investing in Twitter. It's entirely possible that the company will reach these aggressive growth figures. For hints, take a close look at the 2013 financials and listen carefully to what management has to say about future growth. But only the most aggressive of investors should buy the shares at today's prices.

The Keys to Twitter's Growth

So how could Twitter achieve its ambitions? It seems to be following the playbook of Facebook (FB), LinkedIn (LNKD) and other social-media companies that built a massive base of users, and then found ways to profit from them. Facebook, for example, had nearly a billion users before most of its serious revenue-generating ideas were launched.

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Right now, "sponsored tweets," commercial messages that appear in the midst of a Twitter user's timeline, are the most obvious moneymaker. But there are many possible ways that the company can make money in the future, says Peck, including one-click purchasing of tweeted items, commissions on applications that users install after learning of them from Twitter, and advertising results from a search.

Twitter's natural link to television offers a lot of possibility, say both Peck and analyst Dan Salmon, of BMO Capital Markets. "Social TV," as Salmon calls it, is the act of watching television with a "second screen" nearby. Viewers can either interact with other viewers or simply see what they're saying about what the viewer is watching. "In many ways, it is the first real 'feedback loop' for television, which is typically thought of as a one-way, broadcast medium," Salmon says.

He offers an example: Viewers of Monday-night football tweet about a terrible call and include "hashtags," part of the Twitter formatting, that identify them as viewers. At the break, a company could air a commercial and simultaneously promote a tweet for the same product that piggybacks on the hashtags being used by viewers.

If the business model sounds intriguing and the valuation doesn't scare you, put the stock on your watch list. Just be sure to decide what you're willing to pay. Peck, for one, drew the line at $59. He downgraded his rating on Twitter to neutral from buy in mid December after the stock hit that price, which was $9 more than his target for the end of 2014.

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