Yes, The #TwitterIPO is a Risky Investment

Should you invest in the Twitter IPO? Here are some facts about the Twitter IPO.

 

I rarely like to do posts like this which focus on a specific stock and effectively making a specific market call, but with Twitter all over the headlines I couldn’t resist. I have added lots of links to our definition pages and other valuable resources in an attempt to make this post a little more valuable to readers and new investors.

 

 

Reports tonight tell of Twitter topping $26 per share at IPO time (That will likely go up). As an individual investor, how can you research a stock like Twitter that is not yet public, but has an upcoming IPO?

Companies are required to file an S-1 filing with the SEC prior to listing on the stock market. This gives prospective investors an insight into the company’s balance sheet, income statement and cash flows, much like an annual 10-k or quarterly 10-q filing you are familiar with.

For those interested, the 108,000+ word, 200+ page S-1 filing (where all the fundamental data discussed below can be found) is on the SEC’s EDGAR database here:

http://www.sec.gov/Archives/edgar/data/1418091/000119312513390321/d564001ds1.htm#toc564001_14

 

Lets look at some of the fundamental data of Twitter:

Page 11 of the company’s S-1 filing says that over 472 million shares will be outstanding after the IPO (not including many future stock options and RSU’s). That puts Twitter’s market cap at a rough $12 BILLION valuation at time of IPO (again, it may go higher during the day).

 

Some basic fundamental ratios of the company at that price:

Price to Sales Ratio: 38 – 24 times higher than the S&P 500!

Price to Book Ratio: 17 – 6.8 times higher than the S&P 500!

Price per “Monthly Active User”: $60

Price per “Daily Tweet”: $24

I am not sure how you are supposed to value a company based on monthly users of a free website. But since they were the first statistics about the company on the S-1 filing, I figured someone must think it is important.

Profits: $0

 

 

Is Twitter a Risky Investment?

 

What’s one of the most common words in Twitter’s S-1 filing? I created a word cloud of the 200 page filing and after removing the words share, stock and common, here is Twitter’s S-1 filing in picture form:

Twitter word cloud - MAY

 

 

What word stood out to me?

MAY.

As in maybe its a bad idea to risk money on a company with no proven business model or proven way to make profits.

The question was recently asked on CNBC, “Is Twitter a Risky Investment?”

This line should give you a clue: “Wall Street is all-in with a high valuation”

 

Is it risky to pay $12 Billion for a company that has never turned a profit? Is it risky to pay $38 for every $1 in revenue a company does? I don’t think many people would be able to answer “no” to those questions anywhere outside of Wall Street on IPO day. But tomorrow you will find no shortage of Wall Street pros touting Twitter to the masses.

 

The arguments justifying a sky-high valuation on Twitter usually revolve around Twitter’s prospects for growth. Indeed the company is growing and it will continue to grow in the future.

However, just because Twitter is going to grow does not mean it is a good investment. At $26 per share, the current investor is already paying a hefty premium for that projected growth. As Graham explained in his book “The Intelligent Investor”:

“Today’s investor is so concerned with anticipating the future that he is already paying handsomely for it in advance. Thus what he has projected with so much study and care may actually happen and still not bring him any profit. If it should fail to materialize to the degree as expected he may in fact be faced with a serious temporary and perhaps even permanent loss.”

 

 

This is not meant to be a forecast for Twitter’s stock price. The exuberance of Twitter’s investors will more than likely surprise most market forecasters, myself included. The point of this article is to educate and warn the investor of the risks associated with buying an incredibly expensive and over-hyped IPO of a company at a time when market optimism is euphoric. The “Intelligent Investor” should be turning more pessimistic on the potential for increased returns in the stock market, not lining up and paying 38 times sales for a company with no history of positive earnings.

 

To quote Graham one last time:

“While enthusiasm may be necessary great accomplishments elsewhere on Wall Street it almost invariably leads to disaster.”

 

In conclusion

I will be perfectly honest, I have not read all 200+ pages of Twitter’s S-1 filing (Like I did when Facebook went public – you can see my post before Facebook’s IPO here). But I don’t think I have to.

We have talked again and again here on Begin To Invest on the importance of “staying the course”, which means investing responsibly and ignoring the noise from the market and other investors. That means there are days where you will miss out on a big name now and then, but more often then not it means you also miss out on big losses.

Tomorrow’s IPO of Twitter will be filled with extravagant forecasts, inflated egos and an endless supply of greed.

It is times like these that Intelligent Investors can come out ahead of the herd by keeping a rational head, something that will be a rarity on Wall Street tomorrow.

 

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