Talking Stocks: Can Twitter Revive Themselves?
Updated: Feb 3, 2020
When a flawless balance sheet couples with unending political turmoil…we question: where will the stock price end up? This uncertainty cascades among the investing community, and we deliberate whether we’ll be seeing a price of $42 per share or $19 per share instead: two different outcomes that translate billions and billions of dollars apart.
Earlier this year, Twitter banned political ads on their platform and posted slightly poor Q3 results: both of which are moves that cost them a 27% drop in their stock price last month.
Investors are now contrastingly torn on this business, which is why we aim to solve that problem and deduce whether Twitter can make a recovery in the near term.
Without further ado, which aspects can Twitter use to redeem themselves?
1. Extremely Stable Balance Sheet:
With a financial position solid enough to overcome any adversity, the level of security Twitter possesses is incomparable. Three factors in particular may allow the business to build itself up once more:
a) Cash is King
Sitting on over $6 billion in cash gives Twitter the ability to overcome most adversaries within business. While frivolous lawsuits, government regulation, and security breaches cause the eminent downfall of many different companies, the fact that Twitter hold so much liquid cash allows them to sustain their operations and still appease stakeholders, no matter the external factors.
b) Growth Prospects
Holding an adequate level of cash facilitates them to fund growth strategies at a sustainable level: whether it surrounds acquisitions, internal expansions, or technological innovations. Within the tech industry, growth – in both earnings and stock price – generally occurs due to greater innovation, and a significant level of cash reserves will facilitate this undoubtedly.
For example, Twitter have begun investing into an automated system that detects and removes abusive tweets: eradicating media negativity and bringing the company in line with Jack Dorsey’s vision for a “healthier place” online. Thanks to this AI investment, Twitter has already eradicated 50% of abusive tweets, and further capital will be placed to bring that statistic even higher: all of which is possible due to the excess cash held within the company.
c) Overcoming Short-term operational/legal/social issues:
From multiple IP lawsuits to changing political stances, Twitter’s cash balances are also an impetus to retrieve themselves away from monetary trouble. Akin to the way that Facebook and Amazon supersede all their controversies, Twitter hold the publicity levels and financial dominance to eradicate themselves from the path of potential downfall. History, such as the deterioration of Blockbuster, Kodak, and Circuit City* depict that a strong balance sheet substantially aids in the overcoming of short-term constraints, regardless of industry or business in question. The fact that Twitter have sustained reliable balance sheets over a long period indicates their level of financial intellect to investors, and suggests that they hold a good chance of using their capital wisely to regain their financial status.
*What happened here? All three of these companies went out of businesses due to either having no cash in reserve, or holding too much debt: both of which lead to bankruptcy. Because Twitter are victims of neither, we feel more optimistic about their redemption compared to the 3 aforementioned companies.
2. Valuation Factors
In an industry where most firms trade at ridiculously high multiples, Twitter’s P/E ratio is among the best in the business, standing at a sophisticated multiple of 18. In terms of fundamental analysis, legendary investor Ben Graham says that a ratio between 15-30 is strongly favorable: a range in which Twitter’s statistic fits perfectly.
This depicts that their share prices are far from overvalued, which is why we can infer that a “bust” is not imminent here. This is a significant point to make, because firms that generally trade at high P/E multiples tend to plummet within a short period of time, and this is easily depict-able by the marijuana sector below:
Figure 1: Downfall of Marijuana Stocks (Highly overvalued)
Source: (Market Realist, 2019)
The four largest players in the marijuana industry are depicted above, all of who’s share prices plummeted almost 50% since February 2019. This is because they were trading at prices that fair outweighed their fair value, causing investors to sell off their positions and forcing the stock price to “bust” within several weeks. Luckily for us, Twitter’s P/E ratios are nowhere near the dramatization of the ones above, which puts investors at ease and gives us a glimmer of optimism regarding the future of this company.
But is are ratios and strong balance sheets enough to bring Twitter back to its former glory?
3. 2020 Forecasts
At a time where the prospects of Twitter slowly wane with time, the rescuing factor here is that analysts are predicting an 18% improvement in sales next year, with user growth increasing simultaneously. This could be attributed to the fact that the 2020 Olympics in Japan are being held next year, along with several new IPO’s and product releases: all of which would increase activity on the platform and therefore allow Twitter to pump up their numbers to meet analysts’ forecasts.
Key Point: While sales may grow, we may be approaching the “maturity” stage in Twitter’s user growth cycle. This means that consumer usage will still continue to grow, but at diminishing rates, as evidenced below:
Figure 2: Decreasing rates of user growth on Twitter:
Source: (Statista, 2019)
Therefore, the fact that active user statistics are growing at a diminishing rate may suggest that Twitter will hit another roadblock in the near future, and investors will certainly aim to exit their positions when this occurs.
Nevertheless, this is a longer-term outlook as Twitter's current user satisfaction is high; in the near-term however, we can instead expect a pullback towards favorable earnings and user activity: both of which may facilitate a higher stock price within the next few months.
Twitter hold one of the most exceptional balance sheets in their industry, and therefore possess the resources to retrieve themselves to the favorable position that they were in beforehand. Many companies have been figuratively “knocked down” in the past but were unable to reform due to excessive debt and poor cash reserves: both of which Twitter do not hold.
Twitter’s stock valuation and ratios hold well compared to other businesses in the tech sector, therefore creating the idea that they are unlikely to face short term busts in the same way that other companies have done so recently. From this, we as investors can imply that the drop in stock price has reached its lower limit, and we are likely – caution, likely – to see the company hit back home soon.
Despite a rocky Q3 of 2019, analysts are forecasting more optimistic statistics for Twitter in 2020. This, coupled with CEO Jack Dorsey’s proud new plans for the company, may create much better investor sentiment around Twitter and therefore return its price to the 52-week high of $42 per share.
The merits of Twitter’s fundamentals are incontrovertible: it is a solid business that holds the resources to grow even further. However, with the more pre-cautious steps being taken – no political ads, no abuse, no negativity – it seems as though the company are prioritizing ethics over shareholder value with each passing quarter.
In the short term, these steps may be outweighed by the fundamental strength of Twitter as well as their positive 2020 forecasts: both of which could bring the company back to selling at $42 per share. However, in the long run, the move towards better ethics may come at the opportunity cost of poorer profitability, which is why we could see Twitter sustaining a BUY sign in the short term, but transitioning to a HOLD or even a SELL if shareholders are not appeased and low earnings persist later on.