Social media stocks have been the new investment fad. Investors and Wall Street have been singing the praises of the potential these businesses have, and have been valuing them according to that potential. When a social media stock doesn’t do as well as expected, there seems to be a number of justifications for the poor performance. However, the constant sentiment is that these businesses are the future, and it would to pay for future potential now. This seems counter intuitive to the intelligent investor, who knows that a business’ value is equal to the present value of its future cash flows. When the overall market begins to value company’s by anything other than the present value of its future cash flows, any price for any investment could be justified.
The question we must ask ourselves is, what would we pay for a company? When we look at Twitter, we must ask if we would pay $24 billion for a company that lost $600 million in 2013. Of course, we actually don’t have $24 billion to buy Twitter completely, but when we buy shares of any company, we are agreeing to pay the overall capitalization of the company and its “value” at a per share level. When we lose sight of the necessity to receive compensation from the businesses we invest in, we could make poor decisions in our valuation approach. Would we base our valuations on the potential to reach a market? Would we multiply the number of users by projected advertising revenue? Or do we base our valuations on the popularity of a particular stock? It seems as if we have forgotten about the tech bubble, and the way bubbles work in general.
Twitter has not turned a profit. It had negative cash flow in 2012, and is cash flow positive largely because of its IPO. As an intelligent investor, we need to be honest with ourselves and realize the difference between speculation and investment. The only way a person who buys twitter stock would make a return on their investment is by selling it to someone who is willing to pay an even higher price for it. Now I’d be a hypocrite if I said I don’t speculate from time to time, but I’d be lying to myself and to you if I called a speculation an investment.
I like Twitter. I use it to promote myself and my business, and I know millions of people do the same, but it doesn’t make it a good investment. I also like to eat and my wife likes to cook, and I know everyone in the world needs to eat, but that doesn’t mean I should open up a restaurant with my wife.
When we invest in businesses and assets there should be one thing we are concerned with, and that’s a return on our investment. Since we invest using the cash, or capital, we have we should expect a return on our capital. We receive this return either through dividends or income paid to us by the investment, or through the gain we receive on the future price that we sell the investment for. Sound investments allow us to achieve both, while any return on a speculation is gained by buying low and selling high. When we look at Twitter, we see that their are no dividends. There also isn’t a P/E ratio since the company isn’t generating a profit. I usually ignore P/E ratios and focus on P/CF since dividends are paid in cash and not in earnings, but Twitter isn’t generating any operating cash either! We do see erratic price behavior as the market tries to price this company. It’s interesting to me that Wall Street is one of the only places where it is generally acceptable to invest in and value businesses that do not generate any income, capital or value for the shareholder.
If the company was private, and an investor was serious about making sound investments that created value for them, I don’t think that it would be priced nearly as high as it is or has been (43 billion before the annual report!). I think we need to stop looking at the names of companies and look at the numbers before we invest. We should also seek dividend income as a way towards better returns on our investments. Overall, we should value businesses on the present value of their future cash flows and avoid “investments” that don’t add any value or return for us.
The question remains, what would you pay to own Twitter? Hopefully nothing.