Shares of social media platform Twitter (NYSE:TWTR) have been on fire in 2019, with Twitter stock rallying nearly 50% year-to-date. Deservedly so. Twitter’s numbers have been really good this year – big user, revenue, and profit growth in each of the three quarters Twitter has reported in 2019.
The market backdrop has been favorable, with the S&P 500 up 16% YTD. And, the valuation on Twitter has consistently left room for further upside.
That’s why I’ve been bullish on TWTR stock for pretty much all of this 2019 rally. See here, here, and here.
But, with Twitter now trading above $40 (a level which the stock has never sustained for more than a few months) I’m less bullish than I’ve been on TWTR in a year. Indeed, I’m actually somewhat bearish here.
Readers of my writing know that I believe stocks need to check off three boxes in order to head materially higher. They need good fundamentals, technicals, and optics. Of those three, the fundamentals are most important. Right now, Twitter stock is supported by favorable optics and technicals. But, it critically lacks the most important characteristic necessary to go higher: Good fundamentals.
That is, Twitter stock above $40 simply seems overvalued at the current moment.
Consequently, I think now is a good time to do some profit-taking. This is a great company with a lot of long term growth firepower. All that firepower will power TWTR stock higher long term. But, in the near term, the stock seems maxed out, so there’s nothing wrong with selling here and buying back later on a dip.
Twitter Stock Has Strong Optics and Technicals
For all of 2019, Twitter stock has been supported by favorable optics and technicals. It remains supported by those two things today.
On the optics side, Twitter checks off all the boxes investors would want to be checked off for a digital ad company. User growth, even amid all these headline scandals regarding fake accounts and spam content, has remained broadly positive for the past several years, growing (for the most part) at a 10% or better clip each quarter.
Ad revenue growth rates have remained robust. Margins are mostly heading higher. Profit growth has been rock solid. The company has also mostly side-stepped regulation coming out of D.C.
Meanwhile, Twitter has essentially zero exposure to China. It’s only exposure to the trade war is if the trade war gets ugly enough to impact domestic advertising spend and we seem a far way off from that at the current moment. At the same time, low interest rates in the U.S. help support the big valuation on TWTR stock by increasing the present value of Twitter’s future profits.
Net net, then, Twitter stock has been supported and remains supported by favorable optics. 
Click to Enlarge
The same is true on the technicals side. TWTR stock put in a bottom in early 2019. The stock has been on a solid uptrend which has been supported by a strong support line of higher-lows ever since.
That support line has been tested three times. It held every time. Further, the stock trades well above that support line today, meaning that the stock is showing no signs of breaking this uptrend anytime soon.
The Fundamentals Give Some Pause
While the optics and technicals are cause for bullishness on Twitter stock, the fundamentals should give investors pause at the current moment.
There are a few things here. First, Twitter’s revenue growth trajectory is flattening out. Revenue growth peaked in the third quarter of 2018 at 29%. Ever since, the revenue growth rate has dropped, from 29% in 3Q18 to 24% in 4Q18, to 18% in 1Q and 2Q19. Next quarter, the guide calls the revenue growth rate to drop to narrowly above 10%.
Second, Twitter’s margin expansion narrative has actually turned into a margin compression narrative. Throughout 2018, Twitter’s adjusted EBITDA margins were flying higher. But, that margin expansion narrative peaked in the second quarter of 2018.
Back then, adjusted EBITDA margins on a trailing 12-month basis jumped more than 130 basis points sequentially. By comparison, trailing 12-month adjusted EBITDA margins dropped five basis points sequentially in the first quarter of 2019, and another nearly 100 basis points in the second quarter.
Third, the valuation is over-extended. Twitter has controlled around 1% to 1.1% of the global digital ad market for a few years now. At low double-digit user and revenue growth rates today, Twitter most reasonably projects to keep controlling 1% to 1.1% of the global digital ad market for the foreseeable future.
Given current trends, I see that market running towards $650 billion by 2025. At 1.1% share, that implies over $7 billion in revenue for Twitter by 2025.
Margins should keep grinding higher as increased scale drives positive operating leverage. I think adjusted EBITDA margins can hit around 45% by 2025, versus roughly 40% today. This combination of $7 billion-plus in revenue and 45% EBITDA margins leads me to believe that $2.50 is a realistic 2025 EPS target for this company.
Based on a digital ad stock average 25-times forward multiple, that implies a 2024 price target of more than $60. Discounted back by 10% per year, that equates to a 2019 price target of under $40 – versus Twitter’s present price tag north of $40.
Bottom Line on Twitter Stock
Twitter is a great company, and the platform is a great platform. Users aren’t churning, nor will they anytime soon. So long as usage on the platform remains robust (as it should) then ad dollars will keep migrating to Twitter, implying sizeable revenue growth prospects over the next several years. At the same time, margins should continue to improve with scale, further implying sizable profit growth over the next several years.
Ultimately, that sizable profit growth will push Twitter higher in the long run.
At the moment, Twitter stock is overvalued considering its realistic long term growth potential. Given that this overvaluation is on the heels of a 50% YTD rally, it is probably best interpreted as a “sell the rally” opportunity.
As of this writing, Luke Lango did not hold a position in any of the aforementioned securities.