Will the Twitter IPO Ignore Fundamentals and Outperform like Tesla, Netflix and Facebook?

It's almost time for the Twitter IPO. Are you looking at the numbers, the hype, or both?

We already know there’s a lot of talk out there about the rapidly approaching Twitter IPO. In fact, we were comparing the social media giant to the Facebook (FB) IPO just two months ago.

And we’re still coming up with investing ideas for those uninterested in putting money in tweets.

Twitter kicked off its investor roadshow in New York City, hoping to raise roughly $1.5 billion upon selling shares valued between $17 and $20 a pop:

twitter ipo data

Source: USA Today

And the New York Stock Exchange, hoping to avoid some of the pitfalls of the Facebook debut, ran a ‘simulated IPO’ over the weekend. That’s right, Wall Street is so focused on the fate of Twitter’s public listing, that the NYSE ran tests to determine possible effects that could result from the Twitter IPO.

On one hand, it may be comforting for investors to know that the launch of Twitter’s shares is being closely monitored.

But amid all the hype, will some investors miss traditional, tried and true fundamental numbers? Facebook went public at $38 per share. The stock hit more than a few bumps in the road, including dropping to $17 per share. But now some analysts are setting a target price of $65 for Facebook – and excitement around the company continues to grow.

Do the numbers add up? Consider some other stocks that have tripled in the last year alone.

Are fundamental ratios even worth considering?

Tesla (TSLA) has almost hit $200, up 400% in 2013 and valued at a price to sales (P/S) ratio of 15.15. Netflix (NFLX) is up 254% year-to-date and has a P/S of 4.84. Both companies have brought in healthy returns over the last year, outperforming Facebook, which has a higher P/S at 20.44.

​Click on the interactive chart to see returns over time for Tesla, Netflix and Facebook.

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A P/S ratio is a valuation metric that compares a stock’s price to what the company generates in revenue. When a company has a low P/S ratio, it means that its price is cheap in relation to the company’s revenue.

If a stock’s P/S is below 1, it can be considered undervalued. However, investors should note that this ratio doesn’t take expenses or debt into consideration, and variation between industries is normal.

But for companies like Facebook, Tesla, Netflix (and Twitter), do valuation metrics matter? Facebook has a higher P/S ratio, and analysts are setting higher target prices for the stock. 

Investors should ask themselves, what is driving growth – excitement, or solid business strategies? And how do these companies relate to the overall health of the economy?

Blame quantitative easing

While the stock market has recovered post-financial crisis - supported by quantitative easing (QE) - food stamp usage surged 81% to 47.6 million in the US. The number of people relying on food stamps is a relatively strong indicator of economic growth, as it demonstrates the number of people who need help providing their most basic needs.

Meanwhile QE is pushing the valuation of shares higher. Even though Netflix and Tesla are both exhibiting strong customer growth and demand, their lofty valuation might be moving too quickly:

Click on the interactive chart below to see data over time. 

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Bubbles can be invisible until after they pop

High valuations may also be apparent for Twitter and Pinterest. Based on its expected offering, Twitter is valued at $10-13 billion, even though the company lost $133.8 million in 2013.

Recent fundraising by Pinterest suggested the firm is worth $3.8 billion, although it hasn’t announced an IPO (yet).

And since we’re talking about social media companies, LinkedIn (LNKD) is valued at a P/S ratio of 21.52. Shares reached another 52-week high recently, though they pulled back by 6.5%:

​Click on the interactive chart below to see data over time. 

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Is up the only way to go?

The next few weeks will be crucial for richly valued stocks. If the Twitter IPO is well-received, then investors should not expect any profit taking, at least not right away.

This emphasis on highly valued, technologically savvy companies feeding consumer demand for instant and exciting products shows no sign of slowing down. Whether or not an individual stock’s fundamentals, like P/S ratios, will play a role is hard to determine.

The question is, do investors have a fear of heights?

Written by Chris Lau and Emily Smykal. â€‹All data in charts sourced from Zacks Investment Research.


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