Turning Bullish On Twitter
Summary
- TWTR has been consistently pummeled in the past several months.
- Earnings estimates have moved lower, but the valuation has improved immensely.
- With critical support just below today's price, I'm turning bullish on Twitter, provided it can hold support.
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Growth stocks, as well as technology stocks, have been pummeled in the past few weeks. There are concerns about valuations in light of rising rates - which are being fueled by inflation fears - and stocks that are reliant upon high valuations are suffering mightily. For stocks that aren't delivering on forecasted growth, the pain has been so much worse.
One such stock is former high-flyer Twitter (TWTR), which has lost half its value since its 52-week high and has been in a constant downtrend since October.
Source: StockCharts
The chart is just ugly at this point given the amount of selling we've seen, and there's a lot to be bearish about here. But Twitter is on the cusp of potentially making a tradable bottom. If this tradable bottom doesn't form, and support fails, however, get out and run for the hills.
We'll start with the bottom two panels, which show relative strength. We can see Twitter has been awful against its peer group all year, and the peer group has been awful against the S&P 500 since September. Underperforming stocks in underperforming groups are exactly the opposite of the kinds of stocks we want to own, and Twitter looks horrible on these measures.
If we turn to the accumulation/distribution line, it is also making new lows, which indicates that Wall Street is selling the rips rather than buying the dips. This is another form of bearish behavior because rallies are being taken as opportunities to get out, rather than adding into strength.
But despite all of this negativity, there is one thing that has me more optimistic, and that is the possibility of a positive divergence occurring at critical price support. Twitter goes for $40 today, and it's been at that level for weeks now. But if we look at the PPO and the 14-day RSI, both are putting in pretty strong positive divergences, meaning that it is possible investors have drawn the line in the sand right here. If you wanted to own Twitter, now looks like a great time to do that based upon this support level coinciding with a positive momentum divergence.
If you do buy it, please keep a stop loss just below, say $38 or $39, to avoid a waterfall decline should support break.
Now, let's take a look at the fundamental picture, which will help provide some color as to why the stock has been beaten down the way it has.
Revenue is okay, but expenses keep rising
Let's start with revenue revisions, which are plotted below and provide some context for the mess Twitter has been in.
Source: Seeking Alpha
Revenue estimates bottomed in 2017, and have risen gradually since, excluding the early part of the pandemic in 2020. We've seen fairly large revisions upward since the latter part of 2020, but we can also see some of that enthusiasm has since been unwound, in the form of slightly lower estimates of late. That's not a great story, particularly for a growth stock that relies upon torrid revenue growth, and it is little wonder Twitter's getting pounded.
Advertising revenue, for its part, has recovered nicely from the pandemic period. We know that any business that was reliant upon ads suffered through the pandemic as businesses panicked and spent far less on ads. That condition has abated entirely and Twitter's revenue is back to normalized levels, so I don't necessarily see that as a problem.
The company has said it's seeing strength in gambling, financial services, crypto, retail, technology, and other sectors, so again, I think Twitter's revenue is okay at the moment.
What's not okay is the company's expenses, as soaring costs are destroying margins. Below we have revenue in millions of dollars (blue bars), gross margins as a percentage of revenue (black line), and operating margins as a percentage of revenue (green line). All numbers are trailing twelve months.
Source: TIKR
Gross margins have certainly moved around some in the past few years, peaking at 68%+ in 2018/2019, but hitting just 64% for the most recent four quarters. That has hurt profitability, as you'd imagine it would, but soaring costs are really the culprit here, and almost certainly why the stock has been left for dead as it has. Operating margins, as a result, have been cut in half, meaning Twitter now has to produce twice as much revenue to make the same operating profit that it did a few years ago.
For instance, Q3 operating costs rose sharply in Q3, driven by a 34% increase in the cost of revenue, as well as a 55% increase in R&D, and a 40% increase in SG&A. Twitter is making significant investments in selling, product design, and personnel, and it's possible we'll see those investments pay off in the years to come. But for now, it appears Wall Street has lost patience with Twitter's spending and the EPS crush that accompanies it.
Just to finish off this point, below we have trailing-twelve-months R&D and SG&A costs in millions of dollars.
Source: TIKR
The increases here have been significant for both values, with just these two areas combining for ~$2.7 billion in costs in the past four quarters. That's huge in the context of $4.8 billion of total revenue, and it's why operating margins are as low as they are.
Now, let's turn our attention to EPS, because given what we've seen above, we can expect some significant weaknesses. We know that revenue is growing nicely out of the pandemic, and that's one of the three pillars of EPS growth. The second one is margins, which we looked at as well, and we also know margins are weak due to very high levels of spending growth. The third is the share count, which we haven't looked at.
Source: TIKR
We can see outstanding shares have risen gradually over time, but the average increase in the past five years has been something like 3%. The past year has seen a much smaller increase so I'm hopeful that Twitter will see less dilution than it has in the past, but this is something to keep an eye on. At the moment it remains another headwind for a company that could do with fewer headwinds.
All of what we just looked at boils down to EPS estimates, which we can see below.
Source: Seeking Alpha
EPS revisions have tanked since the end of 2019 and have only gotten worse. For instance, this past summer saw a massive decline in 2021 EPS (which hasn't been reported yet), and while the damage was lighter in the out years, the fact is EPS is moving in the wrong direction.
The bottom line is that Twitter has some real issues at the moment despite the fact that revenue looks to be in pretty good shape. Wall Street is forgiving of massive amounts of spending if earnings projections are moving in the right direction. Twitter's just aren't, and with 2021 EPS estimates having declined by about three-quarters in the past year, it's no wonder the stock has been punished the way it has.
Now for some good news
The consolation is that Twitter is actually pretty cheap these days, even taking into account its lower estimates. Let's start with price-to-sales, which I've plotted for the past five years below.
Source: TIKR
The P/S ratio topped at just under 12X in 2018 and topped at just under 13X in early 2021. The bottom during the COVID panic was 4.3X, and we're at 5.6X today. That's a very cheap valuation for Twitter, and well below its median of 7.7X over the past five years. On a revenue basis, particularly since Twitter's revenue looks okay, the stock looks oversold.
Let's now turn our attention to price-to-earnings.
Source: TIKR
Twitter peaked at 101X earnings in 2020 but has since seen its valuation plummet. This is despite the fact that EPS estimates have declined; the share price has managed to fall enough to make the stock cheap, even on lower estimates.
We're at 45X forward earnings today, and while I won't try to convince you Twitter is some sort of value stock, that is a very cheap valuation for this company. The average in the past five years is 54X earnings, so again, Twitter looks pretty reasonably valued to me.
The bottom line on Twitter is that we have a lot of bad news, but also some good news to balance it out. On the one hand, Twitter's revenue recovery has worked and it seems well on its way. On the other, expenses are absolutely flying and Wall Street is having none of it. Margins are suffering and earnings revisions are horrendous for the past few months.
On the technical side, there's critical support just below the current share price, and a significant positive divergence occurring.
The valuations also look relatively cheap to me for both revenue and earnings, so when I consider all the evidence, Twitter looks like it is worth a shot here. It has a lot of problems but those problems look priced in at the moment. Keep your stop loss in place, but for me, Twitter looks strong on a risk/reward basis at the moment, and I'm turning bullish.
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This article was written by
Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, but may initiate a beneficial Long position through a purchase of the stock, or the purchase of call options or similar derivatives in TWTR over 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.
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.
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