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There’s No Need to Rush Into Plunging Twitter Stock Yet

Twitter (NYSE:TWTR) stock plunged by more than 20% in late October after the social media company reported third-quarter numbers that — while ostensibly very strong — didn’t quite live up to supercharged investor expectations. Twitter stock had, after all, surged more than 60% year-to-date heading into the print.

Twitter (TWTR) app being shown on a phone screen held in a person's hand.
Source: Worawee Meepian / Shutterstock.com

Plenty of Wall Street analysts are rushing to Twitter’s defense after the huge selloff.

Pivotal Research called the pullback “unwarranted” and raised its price target on TWTR stock to $64 (implying 60% upside potential). Deutsche Bank also raised its price target on TWTR stock to $64. Mizuho Securities, RBC and many others also raised their price targets on Twitter stock to levels above where shares currently trade.

The implication? Wall Street is saying buy the post-earnings dip in TWTR stock.

But I’m not so sure. As someone who called this post-earnings plunge, I remain bearish on Twitter stock, because the company is still the weakest in the social media space yet continues to feature a premium valuation.

Indeed, I wouldn’t be a buyer of TWTR stock until the $35 level.

Here’s why.

Twitter’s Shaky Earnings

Ostensibly, Twitter’s third quarter earnings report was a smashing success that featured huge revenue and profit beats with much better than expected revenue growth and margin performance.

But, when you dig deeper, the report had some problems.

First, user growth decelerated meaningfully in the quarter. That is, since early 2018, Twitter has been on a steady streak of accelerating user growth, from 9% in the first quarter of 2018, to 34% in the second quarter of 2020. That streak ended this quarter, as user growth slowed to 29%, and the daily active user base inched up by just one million globally (and actually shrunk domestically).

That’s not good. The underlying trend here implies that Twitter usage is nearing saturation globally, and that user growth rates going forward will flatline.

Second, margins are projected to come under pressure going forward. Specifically, management is targeting 20% expense growth in the fourth quarter of 2020. The company reported just 14% revenue growth in Q3. So, unless revenue growth picks up substantially (which is unlikely), Twitter’s profit margins will come under pressure in Q4 — not a good sign for a company whose bull thesis hangs substantially on margin expansion.

Third, the 14% revenue growth rate in the quarter is the weakest in the digital ad space. Facebook (NASDAQ:FB) reported 22% revenue growth in Q3. Snap (NYSE:SNAP) reported 52% revenue growth. Pinterest (NYSE:PINS) reported 58% revenue growth.

So, while Twitter’s revenue numbers did top sell-side expectations, they also pale in comparison to what everyone else reported in the same period. The fact that Facebook, Snap and Pinterest are all rattling off 20%-plus revenue growth rates and Twitter can’t even break 15% speaks to the platform’s underlying problem that ads and Twitter simply don’t mix well.

All in all, don’t let the headline beats fool you. Twitter’s earnings report was not good.

Twitter Stock is Interesting at $35

Given Twitter’s shortcomings as a digital ad platform, TWTR stock remains overvalued, even after the 20% post-earnings plunge.

I previously pegged Twitter’s long-term earnings power at $3.50 in earnings per share by 2030. I’ve revised that estimate somewhat higher, to account for better-than-expected Q3 revenue numbers. But not too much higher, because again, while Twitter is a great platform that we all use, it’s simply an ineffective channel for digital ads.

I now see Twitter’s 2030 earnings coming in around $4 per share. Based on a 20X forward earnings multiple and an 8.5% annual discount rate, that implies a 2020 price target for TWTR stock of ~$38.

Thus, you want to buy Twitter stock at a discount to $38. Conveniently, the stock’s next major technical support level is at $35, which is the stock’s 200-day moving average.

To that end, I think Twitter stock looks interesting if it falls down to $35, but uncompelling anywhere between here and there.

Bottom Line on TWTR Stock

The market got overly excited about Twitter. Now, investors are paying the price. Unfortunately, although sell-side analysts want to be cheerleaders and are saying buy the dip, the pain is not over.

The reality is TWTR stock is still overvalued. Shares will continue to correct lower for the foreseeable future. The bottom may not show up until $35.

On the date of publication, Luke Lango did not have (either directly or indirectly) any positions in the securities mentioned in this article. 

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