Is Twitter the Canary in the Coal Mine?

Investors are shrugging off the suggestion that stocks are over-valued or that the technology innovators are a one-way path to riches if the year-to-date performance of Tesla Motors (TSLA) and Facebook (FB) are any indication. Twitter’s stock (TWTR), which soared from a $45 closing price on its first day of trading (November 7, 2013) to a high of $73.30 on December 26, has fallen 32% since the start of 2014. Twitter is now trading at slightly below $45. Given the excitement surrounding the Twitter IPO less than six months ago, what does this apparent reversal of (expected) fortunes suggest? It is certainly too soon to conclude that a business model that made sense at the IPO has proven to be faulty. Does Twitter’s dramatic decline signal a shift in investors’ willingness to bet heavily on a future earnings stream that is almost impossible to predict?

Twitter is still an incredibly valuable company, even after its slide. At its current price, Twitter has a total firm value of more than $25 billion, roughly equal to the market value of Kellogg (K, the major foods company) and just a bit less than Northrup (NOC, the aerospace conglomerate). Tesla Motors (TSLA) has a current market value of just over $25 billion.

So far in 2014, we are seeing a remarkably rapid divergence in performance between the growth stock companies that have managed to maintain investors’ faith and interest (TSLA, FB) and those that have not. Twitter is a very visible example. Investors in a company like Twitter or Tesla are investing on the basis of expectations of future stratospheric growth rather than upon a track record of proven performance. Since the start of 2014, we have seen investors lose faith in Twitter but not in Tesla. Companies with virtually no earnings (Twitter and Tesla) rely on investors to project that there will someday be earnings. The value of the firm is all about prediction of earnings growth. The same can be said, albeit to a lesser degree, for firms which have earnings but that trade at ridiculous multiple of P/E. Amazon (AMZN) is an awesome company that I admire greatly. That said, AMZN trades at a P/E of 570 even after an 18% price drop for the year-to-date. To justify this type of P/E, the company needs to grow its earnings at an astronomical rate. LinkedIn (LNKD) trades at an even more astounding P/E of 768 after a price drop of 15.4% so far in 2014.

Investing Guru Ben Graham famously quipped that in the short-term; markets are a ‘voting machine’ and that in the long-term they are a ‘weighing machine.’ Before a company has a track record of earnings, its valuation can only be determined by the ‘voting machine’ of investor opinion. At some point, however, some portion of investors will realize that their opinions are highly uncertain and will realize that the value of these companies is almost entirely in the faith of other investors. The substantial declines in 2014 to date, typified by Twitter, suggests to me that some critical population of investors are losing faith in infinite growth prospects.

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