Twitter IPO Coming; Should You Invest?

With news that Twitter Inc. is about to make an initial public offering (IPO), there’s already a lot of buzz and publicity surrounding the event.

And there’s one big question most investors are probably asking: should you consider investing in Twitter?

Generally speaking, investing in stocks after their IPO is extremely dangerous, and many investors have lost money doing so.

If one is fortunate enough to be allocated shares prior to the IPO, that is a different matter altogether. But for most of us, we are considering investing in stocks on the secondary market, once shares are publicly traded.

The social media technology market sector is extremely hot, as you’re probably aware of. The main reason is that the social media market sector is one of the few that is seeing a huge increase in growth in terms of users and revenues.

However, while Twitter is seeing growth in many areas, net income is not one of them. One of the issues when it comes to investing in stocks in the social media market sector is that growth is seen as the main target, while net income lags. With Twitter, the theory is build first, profit later; many investors are hoping that Twitter can turn a corner and start generating profits soon.

The company is looking to raise $1.0 billion, which will value the firm at an estimated $12.8 billion. For the first six months of 2013, Twitter generated revenues of $253.6 million, which is essentially double what the firm produced in 2012. On a trailing 12-month basis, Twitter’s valuation would be 28 times (X) its revenues, which is certainly not cheap.

When investing in stocks in the same market sector, to help guide valuation levels, look at relative comparisons between the companies. Facebook, Inc. (NASDAQ/FB), for example, currently trades at 19.5X sales, while LinkedIn Corporation LNKD trades at 22 X sales.

However, both Facebook and LinkedIn are profitable, whereas Twitter is still posting losses, including a loss of $69.3 million for the first half of 2013.

So why is Twitter’s valuation at a higher level than established firms in the same market sector, like Facebook and LinkedIn? Two reasons: the growth rate of revenues, and the company’s ability to monetize mobile users.

Generating revenue from mobile users is crucial for social media market sector stocks. If you’re going to be investing in stocks, you need to know what the variables are that will drive future revenues. Of Twitter’s revenue from ads, 65% comes from mobile devices, which is a much larger portion than what its peers in the social media market sector are seeing.

However, it’s interesting to note that while Twitter continues to grow its user base (up 44% from 2012), that growth rate is actually down from the 78% growth experienced the previous year. This is a caution when investing in stocks that are in an industry as volatile as technology and specifically the social media market sector. Users can flood into a service (or application on a mobile device), and they can just as quickly leave. This makes forecasting extremely difficult for anything but the shortest of timeframes.

And this is my real concern: the timeline when one is looking at investing in stocks. The social media market sector is not going away; that much we already know. However, if you’re a long-term investor, can you be sure that Twitter will still be around 10 years from now? It might be, but I certainly wouldn’t bet all my money on that.

When Twitter’s IPO does occur, I would suggest that rather than investing in stocks initially, wait on the sidelines. Yes, the stock might initially shoot up in value, but you should be interested in investing in stocks for the long term, as a part owner in the company. Considering the volatile nature we’ve seen in other stocks in the social media market sector (recall Facebook’s IPO, when the stock opened at $38.00 and dropped to $18.00 in just four hours), Twitter could move down in price just as easily as it could move up.

This article Twitter IPO Coming; Should You Invest? was originally published at Investment Contrarians