Twitter's Been Flying Sky-High, But Is It About to Crash?

Twitter's Been Flying Sky-High, But Is It About to Crash?

No matter what the market is doing these days, it appears as though Twitter can do no wrong. Even as the S&P 500 fell 1.13% on Wednesday, shares of the social network flew to a new 52-week high, hitting more than double the company's $26 IPO price set last month. However, with all the enthusiasm from shareholders just dying to get a piece of the company, is it possible that shares have become overextended?

How has Twitter done so far?
Looking at the company's market capitalization of $28.5 billion, you might get the impression that Twitter is raking in a few billion in sales. Though the billion-dollar mark may be reached in a year or two, sales currently sit far below that. In 2012, revenue for the company hit $316.9 million. Initially, this may leave some investors wondering how such a small company is worth such a big price. (The answer: Investors are paying for growth.)

To better appreciate the growth engine that is Twitter, we should look at the company's sales over a long period of time. In 2010, revenue came in at $28.3 million, indicating that sales grew 1,019.8% over the past three fiscal years. If analysts are correct about the company's revenue for this year, then Twitter will report sales of approximately $638.3 million by year end.

Interestingly, Twitter isn't the only social media site to see a prolonged growth spurt. Companies like Facebook and LinkedIn have also benefited from an explosion in online spending and, in turn, advertising. Between 2012-2013, online advertising is expected to grow 3.5% to $503 billion, as global online sales could approach $1.3 trillion. Moving forward, analysts expect the growth trend to continue, with online advertising rising significantly through at least 2015 as e-commerce grows in popularity.

In light of this booming industry, Facebook has seen its revenue grow by 157.8%, from $1.97 billion in 2010 to $5.09 billion through 2012. As is the case with Twitter, Facebook is expected to see revenue grow this year, hitting as high as $7.63 billion (if analysts are correct).

LinkedIn's growth rate has been even more impressive over this same time frame. Sales grew 300% from $243.1 million in 2010 to $972.3 million in 2012, as the company has been able to attract advertising dollars. However, it should be mentioned that in 2012, only 27% of LinkedIn's sales came from marketing, down from 30% in 2011 and 33% in 2010. So, its growth rate compared to Facebook and Twitter is overstated.

Looking solely at advertising revenue, LinkedIn grew sales by 225.7% from $79.3 million to $258.3 million by 2012. For the year, analysts expect total sales for the company to come in at $1.52 billion. Assuming the same trend in marketing revenue, sales from the segment can be expected to come in around $364.8 million.

Could profitability become a major impasse?
Investors are buying up shares of companies like Facebook, LinkedIn, and Twitter with the expectation that each will create a sustainable competitive advantage and yield attractive margins like Apple or Microsoft. Though this is possible, early signs suggest there may be some difficulty achieving the desired results.

In each of its past three years, Twitter has failed to profit from its business model. In aggregate, the company's net loss has been $275 million, and is expected to rise again this year. A good part of this has been attributed to management's decision to engage in research and development to such a large extent, but eventually investors will demand a profit.

Both Facebook and LinkedIn have performed better, each managing to make a nice profit, but margins have been suppressed by research and development expenditures.

Foolish takeaway
Looking at the data, it's apparent that Twitter is a high-flying spectacle that has lured investors starved for growth. Although growth is never really a bad thing, shareholders should be concerned about paying too much. Right now, investors in Twitter are paying for a net loss and even if shares don't move and earnings jump such that the company hits a price/earnings ratio of 30, management will have to earn $950 million per year just to make the company reasonably attractive.

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The article Twitter's Been Flying Sky-High, But Is It About to Crash? originally appeared on

Daniel Jones has no position in any stocks mentioned. The Motley Fool recommends Facebook and LinkedIn. The Motley Fool owns shares of Facebook and LinkedIn. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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Originally published