Twitter just priced its initial public offering (IPO) at $26 per share. At that price, the company is worth $18 billion, at least on paper. The offering will undoubtedly spark tremendous excitement and news, not to mention a tweet or two. But is the stock a wise investment?
The answer is unquestionably no. Here’s why.
Recall that the market was all aflutter with the Facebook IPO. The IPO was scarred by glitches on its first day of trading. Still, investors learned that a great company does not necessarily make for a great investment. Twitter is an excellent example of a great company and a bad investment.
To understand why, let’s distinguish between a company’s stock price and its earnings.
Price vs. Earnings
Many factors affect the price of a stock on any given day. The Fed Chairman’s comments in a congressional hearing can cause euphoria or doom in the markets. A foreign country’s debt can rise to an unstable level, causing fear of collateral damage. Or a company’s really cool technology (think Tesla) can cause investors to send the stock’s price unrealistically high (just ask Elon Musk).
The point is that in the short term, many factors other than the actual value of an enterprise can cause the price of its stock to swing high or low. This isn’t peculiar to stocks. Do you remember the housing bubble of a few years ago?
In the long term, however, a stock’s price generally tracks its earnings. It’s the cash that any asset can generate that ultimately determines its value. That’s one reason I purchased more stock in Apple when it dipped into the $300’s earlier this year. Investors were irrationally fearful, in large part because they took their eyes off of earnings (and Apple’s incredible balance sheet).
When I bought Apple, it was trading at a Price-to-Earnings (P/E) ratio of about 9. Today it trades at a P/E of about 13. (Tracking my gains on the investment in my favorite investment tracking tool has been fun.) Keep those numbers in mind.
Twitter Isn’t Profitable
Twitter’s Form S-1 filed with the SEC contains its most recent financial statements. Scrolling all the way down to page F-5 you’ll find its Consolidated Statement of Operations, otherwise known as an Income Statement. For the last full year (2012), Twitter reported total revenue of about $317 million. Its expenses, however, were nearly $400 million, resulting in a loss of about $80 million.
So much for calculating a P/E ratio. You need earnings for that. But let’s assume that Twitter had absolutely no expenses. That’s right, let’s make the ridiculous assumption that its revenue of $317 million all flowed down to income. At a value of $18 billion, that would still give Twitter at P/E ratio of 56.
Some may argue that its revenue will grow, and surely it will. In fact, for just the first nine months of 2013, it has already generated revenue of $422 million, according to its S-1. If we assume it stays the course, it will end the year with total 2013 revenue of about $560 million.
So let’s again assume absolutely no expenses for 2013 (it’s still showing a loss for the first nine months of 2013; in fact, its loss so far this year is nearly double its loss for all of 2012). With that assumption, an $18 billion value would still put its P/E ratio at 32.
Twitter’s Balance Sheet Doesn’t Help
So far I’ve focused on the Income Statement. Twitter’s Balance Sheet doesn’t help its cause, either. To be sure, Twitter appears financially sound. As of September 30, 2013 (unaudited numbers), Twitter has current assets of $500 million and current liabilities of $166 million. That puts its current ratio at about 3, which is quite healthy. It can pay its upcoming bills.
Still, it’s net worth is about $700 million. At a price of $18 billion, it would trade at more than 25 times its book value. By comparison, Apple trades at a Price-to-Book (P/B) value of 3.8, Berkshire at a P/B of 1.3, and IBM at a P/B of 9.7.
Twitter’s Stock Price Doesn’t Matter
Several IPO’s have seen company stock double on the first day of trading. CNN’s Ben Rooney reported that 6 IPOs have doubled this year, including The Container Store and Potbelly. Will Twitter follow suit and double as well?
I don’t know. Nobody knows. And it doesn’t matter. Even if it doubles, it doesn’t make it a good investment. We can’t invest by looking in the rear view mirror. Investing isn’t about fortune telling. It’s about choosing investments that give us a reasonable chance of increasing the purchasing power of our capital.
On that basis, Twitter just doesn’t fly.