Twitter's IPO opened at $45.10. In my recent article I suggested that Twitter (NYSE:TWTR) should be valued at $48. The reasoning why my projection was so close to the actual opening price is because today's "hot social stocks" such as Facebook (NASDAQ:FB) and Linkedin (NYSE:LNKD) are not being valued by traditional means. The valuation method I used was based on a formula driven by the number of users Twitter has, and was compared to Facebook and LinkedIn. I referred to the formula in that article as "Valuation by MAU." The Twitter IPO proved the valuation method is the new reality. Lets give it a better name. I'm going to go with "Price to Users."
Before anyone begins to argue that the market is insane lets just agree amongst ourselves that yes it is. No lets move on. The market is what it is. All an investor can do is decide to participate in the madness or to stay on the sidelines.
This article's intent is to give an investor who would like to participate in this market a rationale to follow that appears to be the driving force behind valuations of these social media stocks. I am not aware of any other metric or traditional valuation method that supports valuations of these companies today. So it makes sense to be fully aware of two metrics that impact "Price to Users" that should drive the stock price of each company that the market decides to price in this way.
- The number of users a social media company has is the starting point. Those figures are below for each of the three companies discussed in this article and the prior article.
- The Price to Users multiple. Currently, that multiple is 106, 104 and 104 for Twitter (using the IPO opening price), Facebook and Linkedin (using closing price on 11/6/13 for both FB and LNKD).
The chart below details the calculation.
So what does this mean? It is shocking, but true, that the market is pricing these three companies at a Price to Users ratio of approximately 100. Pricing these three companies using this metric and being so closely comparable is very interesting. Is the market actually being efficient? I will admit this perceived efficiency appears as though it is resulting from a non-traditional valuation method within a crazy new reality reminiscent of 1999. But nonetheless, on a going forward basis, this new metric, Price to Users, deserves attention.
So the next question is a bit more traditional. Which of these companies will grow its userbase the fastest - which in turn when using the Price to Users metric would result in the largest gain for you, the investor? And please do not refer just to the most recent user growth rates for Twitter. They have been ramping sales and marketing expenses consecutively each quarter since March 2011, which is the earliest quarter we have data for. Don't tell me after raising $1.82 billion that Twitter will not increase spending from the $61 million they spent last quarter. Sales and marketing spending is what grows userbases in the short term. I also believe the user experience will be improved by way of this new capital. Facebook has a massive userbase so its growth rate in turn is always going to be limited by its current massive size. I like Linkedin. My next article will discuss this topic in detail.
Sources: All figures taken from publicly available sources such as Yahoo Finance and Sec.gov
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.