Twitter Soared 20% on July 30: Here's the Logic of That Move (I Think)

07/30/2014 8:04 pm EST

Focus: STOCKS

Jim Jubak

Founder and Editor, JubakPicks.com

A number of analysts have been puzzled by this social media behemoth's stock movement on more than one occasion, raising the question, "What metric should we be watching to value the company?" MoneyShow’s Jim Jubak's answer may surprise you.

Shares of Twitter (TWTR) soared 30% in afterhours trading yesterday after the company reported second quarter earnings. In the full regular session today, July 30, the stock moved up only 20.4%.

And frankly, I’m puzzled. In April, when the company announced first quarter earnings, the shares fell almost 11% because of disappointment that a metric called monthly active users grew by just 6% to 255 million. For the second quarter, Twitter reported 6% growth too—to 271 million users—and instead of falling, the stock soared.

What metric should we be watching in order to value Twitter?

Okay, let’s get the silly stuff out of the way immediately. Nobody is thinking about any measure as quaint as the stock’s price to earnings ratio. Not for Twitter any more than for Amazon.com (AMZN). Twitter’s PE on projected 2014 earnings per share is roughly 652, according to Bloomberg. Makes Facebook (FB) seem cheap at 42 times projected 2014 earnings per share.

And it’s certainly not a metric called “timeline views,” which Twitter applies to measure how much time users spend on Twitter. That metric continued its recent troubling decline. US users refreshed their Twitter feeds 792 times a month in the second quarter. That seems like a lot, I grant you, but it’s a drop from the first quarter of 2014 and from the second quarter of 2013. US users spent an average of 7.2 minutes a day on Twitter’s mobile apps in June, down from 9.2 minutes a day in June 2013, according to comScore data analyzed by Cowen & Company. That’s a 22% drop in a year.

Globally, timeline views fell 7% from the second quarter of 2013, although, thanks to the World Cup, they grew by 4% from the first quarter of 2014. The World Cup was a “tweet” mine for Twitter, with users sending more than 672 million tweets during the tournament. (Which does raise the question, “What do you do in a quarter that doesn’t have a World Cup?”)

The slow growth in monthly active users is an issue for Twitter’s management—if I can judge from the effort that CEO Dick Costolo put into arguing that this metric understated Twitter’s true reach. Many Tweets are embedded in other Web sites and apps, Costolo argued. The size of the company’s true audience is two or three times its active user base.

What impressed investors and Wall Street this quarter enough to overlook that kind of special pleading was revenue. Revenue climbed 124% in the quarter year over year. At $312 million, revenue was up substantially from $139 million in the second quarter of 2013. Twitter also raised its guidance for the full year to revenue of $1.3 billion.

Revenue growth like that indicates that Twitter’s ad system is working—by adding value for advertisers. The metric that I’d watch is average revenue per 1,000 clicks. By measuring whether ad revenue rises or falls for a standard unit of 1,000 clicks, this metric shows how much advertisers are willing to pay more for ad exposure on Twitter. Average revenue per 1,000 clicks doubled in the quarter to $1.60 from the year before. The key seems to be the precise targeting that Twitter’s system allows.

If Twitter can succeed to getting advertisers to pay more for its ads, that could make up for sluggish growth in monthly users and a downward trend in minutes online. Or, at least that’s what Wall Street seemed to be thinking as it read the company’s quarterly report.

Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. When in 2010 I started the mutual fund I managed, Jubak Global Equity Fund, I liquidated all my individual stock holdings and put the money into the fund. The fund shut its doors at the end of May and my personal portfolio is now in cash. I anticipate putting those funds to work in the market over the next few months and when I do I’ll disclose my positions here.

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