Twitter Shares: The Correction Has Only Just Begun

Although we don't believe in timing the market or panicking over daily movements, we do like to keep an eye on market changes -- just in case they're material to our investing thesis.

With just two trading days left in 2013, stocks are near last week's all-time highs, with the S&P 500 and the narrower Dow Jones Industrial Average down 0.04% and up 0.06%, respectively, at 10:12 a.m. EST.

Like the S&P 500, shares of Twitter reached an all-time high last Thursday; unlike the index, they lost 13% in a brutal correction on Friday. That process appears to be continuing today, with the stock down more than 5% at 10:12 a.m. EST.

All it took was a Friday downgrade to underperform (i.e., sell) from Macquarie Capital. In a one-page report ("among the shortest downgrade notes you've ever read"), Macquarie's Ben Schachter wrote that "we continue to believe that Twitter as a company has a bright future and many opportunities ahead; however, as a stock, we believe nothing has changed over the last 15 days to justify the rise in valuation."

That observation is not the product of a rare insight; I offered a similar one on Thursday in warning investors to avoid a Twitter hangover: "The remarkable thing about this meteoric rise [in the stock price] is that it has occurred in the context of virtually no additional fundamental information concerning the company."

The Macquarie downgrade was just an excuse for a correction. When sentiment and momentum are the only things driving the stock price, it's "live by the sword, die by the sword," i.e., news that ought to be relatively inconsequential can have an outsized effect on the downside, as well as on the upside. Macquarie's report did not magically reduce Twitter's intrinsic value by 13%, but it was enough to remind investors that the concept exists and cannot be ignored indefinitely.

Why do I believe Friday's correction marks the beginning of a difficult period for Twitter shares? For one thing, this morning's price action suggests that sentiment toward the stock has changed -- the euphoria has peaked. Second, even after Friday's decline, the stock remains extremely expensive, yielding a company market capitalization equal to nearly 36 times' next 12 months' revenue estimate.

Finally, there are predictable catalysts for further declines on the horizon: more analyst downgrades. As Schachter warned in his note, "Because of Twitter's run and rules around price targets, we expect many other analysts will quickly have to either justify raising targets (based on little new information) or downgrade." According to S&P Capital IQ, the median target price for Twitter's shares among 23 analysts is $46 -- 28% below Friday's closing price.

The start of the year may be a time for hope and optimism, but unless Twitter shares begin 2014 well below Friday's closing price (which could yet happen, I suppose), the same conditions that lifted the shares above $70 last week have set the stage for disappointing returns over the next 12 months.

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The article Twitter Shares: The Correction Has Only Just Begun originally appeared on

Fool contributor Alex Dumortier, CFA has no position in any stocks mentioned; you can follow him on Twitter @longrunreturns. The Motley Fool recommends Twitter. 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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