In my experience consistency is not a trait that successful paid traders often possess. They have beliefs, maybe even convictions, but those beliefs and convictions are always fungible. As a situation changes and evidence indicates that their previous position is now wrong they will abandon it, no matter how right it may have been to that point. I often think that politicians could learn a thing or two from traders in that respect. It seems that we like to elect people with consistent and firmly held beliefs, but positions based on data, evidence and reality, rather than an unshakeable certainty that your world view is right, would probably lead to better policy... but I digress.
In fact, for a trader, a mind open to change is not just desirable, it’s essential. Positions, no matter how successful in the past, must be constantly re-evaluated. Just because being long or short something for a few hours, days, months or years has been right doesn’t mean it will continue to be so. Often that re-evaluation reveals a reason not just to cut the position, but to actually turn around to the opposite view... which brings us to Twitter (TWTR).
I have been bearish on TWTR for some time and over the last 5 months or so that has made me look pretty smart.
The stock has lost around 55% since the high in late December. It seems that others have come around to my view that profit potential is not as valuable as proven profitability. At the height of the madness in December TWTR was trading at a high multiple of even the most optimistic estimates of the next two years earnings despite never having made a penny. It seemed obvious to me that that was unsustainable. Now that seemingly everyone has come around to my way of thinking, however, I have changed my mind.
This isn’t just about the natural contrarianism of a curmudgeonly old man. As the price of TWTR has fallen two basic things have changed.
Firstly, from a technical perspective, it looks like we have found a bottom. There is no law that, having bounced off it twice, the $30 level will hold. What that previous price action does do though is give a logical stop loss level. Establishing a stop on a clean break of that support, at around $29, would limit potential losses to around 15%.
Of course, having a convenient stop loss is great, but only worthwhile if there is something to suggest that you won’t hit it immediately. There has to be some fundamental reason to believe that a falling stock is about to turn. As I re-evaluated my position on TWTR recently I realized that there was such a reason, and it was based on a very simple calculation.
A large part of my logic in forming a bearish view of the stock was that 7 months ago, when TWTR went public, it was at $26. Now investment bankers are human and can make mistakes, but when some of the smartest minds on Wall Street, with access to all of the financial records of the private company and every management plan for future revenue and costs arrive at a number it is not a shot in the dark.
If we accept that that $26 initial offering price was a realistic assessment of the value and potential of TWTR at that point, then factor in actual growth since then, a case can be made that the stock is now undervalued.
My biggest worry about Twitter since the IPO has been revenue generation. The company has had some success at monetization, probably around the level of success expected by those who set the offering price, but not at the rate that a share price over $70 would suggest. Over the three earnings reports since the IPO, revenue at Twitter has grown 51.6%. If we increase the initial offering price of the stock by the same percentage we arrive at fair value for the stock of $39.41.
Obviously, it isn’t that simple. There is still the worry that, as I pointed out when the last numbers were released, revenue per 1000 page views declined. That is not encouraging, but was offset by user growth. Recent acquisitions in the area of big data and the rumored interest in streaming music, however, would indicate the possibility of diversified revenue sources which makes that much less significant.
At some point I have no doubt that the trendy nature of social media will catch up with the company but that point could well be many years away. In the meantime, with “interactive” the buzzword in TV and elsewhere the future for Twitter from a broader perspective looks decent.
Some may find it strange that as recently as 5 weeks ago I was still negative about TWTR’s prospects but am now a convert to the ranks of the bulls. Having been trained in a dealing room, however, I regard changing my mind when faced with new evidence as a good thing rather than a sign of weakness. That would make me a terrible politician, but it kept me working in a dealing room for nearly twenty years.