U.S. Markets closed

Disappointing Earnings Create a Difficult Problem for Twitter Stock

Vince Martin

Twitter (NYSE:TWTR) stock rallied nicely for most of 2019, and received a healthy valuation as a result. In fact, on an earnings basis, Twitter stock was valued at a substantial premium to larger peers in social media and online advertising.

Disappointing Earnings Create a Difficult Problem for Twitter Stock

Source: Worawee Meepian / Shutterstock.com

But Twitter’s disappointing third-quarter report suggests that premium wasn’t deserved — and still isn’t. Investors aren’t going to pay up for single-digit revenue growth and compressing margins. There are other plays in social media and or online advertising doing better at the moment.

That creates a simple, and significant, problem for Twitter stock at the moment. It’s still receiving that premium to those same peers, if not quite to the same extent it did a little over a month ago. And so Twitter either needs to re-inspire confidence quickly, or TWTR stock could have more downside ahead.

InvestorPlace - Stock Market News, Stock Advice & Trading Tips

Twitter Stock and Peers

Above $30, an investor needs to believe that Twitter stock is more attractive than other similar offerings in this market. Among major names, those include social media rivals Facebook (NASDAQ:FB) and Snap (NYSE:SNAP), along with online advertising competitor Alphabet (NASDAQ:GOOG, NASDAQ:GOOGL).

And there has been a case for choosing TWTR stock over those names. Facebook and Alphabet both face significant risk from a regulatory perspective, with U.S. federal government agencies investigating both companies.

Political worries aside, investors long have worried that Facebook will lose users (particularly younger users) to other platforms. The duopoly in online advertising growth between Facebook and Google is starting to crack, and that latter company has struggled to gain traction outside of ad revenue, excepting its Waymo self-driving vehicle unit. Snap, meanwhile, remains unprofitable.

In that context, Twitter seemed lower risk. And while its revenue growth lagged that of Facebook and Alphabet, the company had room to grow margins and thus profits at a higher rate. Twitter was attracting more advertisers and better monetizing its users, boosting long-term growth hopes as well.

Indeed, through the first nine months of the year, Twitter stock outperformed both Facebook and Alphabet. It lagged SNAP, but so did the rest of the market: That stock has been one of the market’s best performers this year, even after a recent pullback. Investors were reacting to what looked like an attractive long-term opportunity with potentially less risk than other major stocks in its group.


The ‘New’ Case for TWTR Stock

That said, there was one underlying risk for TWTR stock. In late August, I called out the company’s elevated operating expenses as a risk to margins. It was guidance for similarly high spending on the health of the underlying platform that led FB stock to the largest one-day loss of value in the history of the stock market last year.

Through the first half of the year, Twitter’s revenue growth had been enough to offset that spending. That changed in the third quarter. Revenue grew just 9%, thanks to lower per-user monetization. Guidance for the fourth quarter was weak as well.

In both cases, Twitter called out “bugs” in its mobile application promotion product and issues with “certain personalization and data settings” as headwinds to revenue. But those issues only hit revenue growth by “3 or more points” in Q3 and are guided to an impact of “4 or more points” in Q4.

Backing that out, revenue grew 13% in Q3 and at the high end of guidance would increase 15% in the fourth quarter. Both figures are a notable deceleration from the first half. More importantly, both materially trail the outlooks for Facebook and Google.

In other words, Twitter now isn’t growing as fast as its larger peers, let alone Snap. It has the same spending problem that sent Facebook stock tumbling last year. Regulatory risk might be lower, but there’s still the question of the so-called “President Donald Trump effect.”

That doesn’t sound like the profile of a stock that should trade at a premium. Yet even one-third below September highs, that’s exactly how Twitter stock trades.

Twitter Still Looks Expensive

Backing out a bit over $5 per share in net cash, TWTR stock trades at roughly 27 times 2020 consensus earnings per share estimates. Both GOOG stock and FB stock sit closer to 20 times.

Again, there was a case that TWTR deserved a premium to those names before the report. Afterwards, that’s a much more difficult case to make. Revenue growth is decelerating. The margin opportunity may not be what was hoped if spending on platform health has to keep rising. User growth has impressed in recent quarters, but it was stagnant before last year and may stall out again.

It’s difficult to pound the table for Twitter stock over alternatives in its group, let alone across the market. In fact, it’s probably easier to argue that TWTR should be valued closer to the 20x earnings-plus-cash figure assigned FB and GOOGL, which suggests a share price closer to $24, another 20% downside from here.

The only way Twitter holds $30, let alone rebounds, is if management can again convince investors that a premium to peers and to the market is merited. If the company can prove that the bugs and settings problems are short term and return to growth, that might be enough. But that’s still a big “if,” and a catalyst that won’t arrive until February. In the meantime, Twitter stock looks like a name to avoid at best.

As of this writing, Vince Martin has no positions in any securities mentioned.

More From InvestorPlace

The post Disappointing Earnings Create a Difficult Problem for Twitter Stock appeared first on InvestorPlace.