Shares of Twitter (NYSE:TWTR) plunged in late October from above $40 to below $30 after the social media company reported lousy third quarter numbers and delivered an even-lousier fourth quarter guide, the sum of which sparked concerns that elevated competition in the digital ad market was materially shrinking the company’s growth trajectory.
Twitter stock has since rebounded from that sell-off as competition and slowing growth concerns have faded. Bullish broad market sentiment hasn’t hurt, either. Today, Twitter stock trades hands around $31.
Don’t be fooled by the recent strength in TWTR stock. The recent broader market rush to all-time highs amid easing geopolitical tensions is creating a rising tide that is lifting all boats in the market, Twitter stock included. Soon enough, this rising tide dynamic will fade. When it does, investors will be stuck looking at the fundamentals underlying Twitter stock, soon to discover who’s been swimming naked.
Unfortunately, those fundamentals today remain as shaky as they were in late October. Competition in the digital ad market is getting stiffer. That digital ad market is slowing. Twitter’s growth rates are consequently falling a by ton. Margins are having trouble moving higher against the backdrop of materially slowing revenue growth. Profit growth is falling flat.
So long as all those things remain true, Twitter stock above $30 looks dangerous.
Twitter has Big Competition Headwinds
Both today and for the foreseeable future, Twitter has big competition headwinds which will keep this company’s growth trajectory relatively depressed.
There are a few things at play here. First, the digital ad market is slowing. This is a natural byproduct of the market getting bigger and reaching fuller saturation of the global ad market. As a result, what was a ~20% growth global digital ad market over the past three years, projects as a low double-digit growth market over the next few years.
Second, in that slowing digital ad market, Twitter is losing market share thanks to rising competition. A few years ago, there were only three relevant players in the U.S. digital ad market: Twitter, Facebook (NASDAQ:FB), and Alphabet (NASDAQ:GOOGL). Now, though, the marketplace includes Pinterest (NYSE:PINS), Amazon (NASDAQ:AMZN), Snap (NYSE:SNAP), Instagram, Messenger, Tik Tok, and many more. As a result, Twitter’s share of the digital ad market has dropped from 1.3% in 2016, to a projected 1.04% in 2019.
Third, Twitter’s growth rates are dropping, since slowing market tailwinds plus compressing market share equals slowing revenue growth. Throughout 2018, Twitter was a 20%-plus growth company. In the back-half of 2019, Twitter projects as a high single-digit revenue grower.
Fourth, margins have stopped marching higher. When revenue growth was big in 2018, Twitter easily turned that big revenue growth into positive operating leverage, and margins powered higher. Over the past few quarters, though, Twitter has had a much tougher time turning slower revenue growth into positive operating leverage. Margins have struggled to move higher.
Putting all that together, competition is putting a lid on the Twitter growth narrative. That competition is only getting stiffer, so Twitter’s growth trajectory will likely remain depressed.
Twitter Stock Above $30 Looks Dangerous
Given that Twitter’s growth trajectory projects to remain depressed, TWTR stock looks dangerous above $30 in 2019.
Here are the numbers. Over the next few years, the digital ad market projects to grow at a low double-digit pace. Twitter will likely lose share in that market as Amazon, Pinterest, Snap, and others gain share. Thus, Twitter projects a ~10% revenue grower over the next few years.
It will be tough to drive huge margin expansion on top of ~10% revenue growth. But, assuming Twitter can exercise disciplined cost control and grow its expense base at a high single-digit rate, then profit margins should keep expanding.
Profit margin expansion plus ~10% revenue growth should reasonably produce 15-20% earnings per share growth. Assuming so, Twitter’s earnings per share could wind up around $2 by fiscal 2025.
Facebook and Alphabet stock have historically fetched around 25x forward earnings multiple. At scale, Twitter stock should fetch a similar multiple. Based on a 25x forward multiple and $2 in 2025 EPS, a reasonable 2024 price target for TWTR stock is $50. Discounted back by 10% per year, that equates to a 2019 price target of ~$31.
Thus, as Twitter stock climbs above $30 in late 2019, caution is warranted.
Bottom Line on TWTR Stock
Twitter’s growth narrative is slowing because of easing digital ad market tailwinds and increasing competition in that digital ad market. Because of this slowing growth, TWTR stock doesn’t deserve the premium valuation that it fetched earlier this year, when the company was growing revenue at a 20%-plus rate.
Where does Twitter stock deserve to trade today? Around $30 — about where it’s set to open today. Thus, big rallies in Twitter stock above $30 should be faded.
As of this writing, Luke Lango was long FB and PINS.