The whole world seems to be a-twitter about the Twitter IPO, which took the investing world by storm on Thursday.
With 70 million shares available for sale, Twitter debuted on the New York Stock Exchange under the ticker TWTR.
Although the initial public offering priced each share at $26, Twitter closed its first trading day at $44.90 per share, up 73%. After Thursday, Twitter’s market capitalization was $34.7 billion, placing it ahead of household names like Time Warner, Yahoo and Kraft, among others.
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Sounds like a promising investment, right?
Not so fast. Before diving in, there are some crucial things you need to know about any big IPO, and about Twitter’s in particular.
What’s an IPO, Again?
Many companies start off as private companies, which means their start-up investments come from individuals and venture capital firms. Those early investors take a huge risk in hopes of big rewards later. When a private company reaches a certain size and stage in its life, it may “go public” and open up its shares to the rest of the world. Going public means more scrutiny of the company’s management, but it also gives the initial owners the chance for a serious payday. During an initial public offering (IPO), cash flows into the company as new investors buy in.
For regular investors, this means the opportunity to buy shares of a favorite company that was previously closed to public investors.
Why Twitter, Why Now
There are lots of factors in a company’s decision to go public, but one big reason Twitter may have chosen to move now is the strength of the market: Within the tech sector, Facebook and Groupon are back on track after big stumbles, while Yelp and LinkedIn are looking healthy. Meanwhile, U.S. stocks are at an all-time high.
Companies must also assess their own strength when deciding on an IPO. Twitter achieved big goals this year on users and revenue, and its money-making initiatives are doing well. Plus, IPOs generate a ton of cash and the company may need the money to free up early investors. If it decides to, the company may also use the money to acquire new companies and go head-to-head with Facebook.
Thinking About Investing?
Especially if you’re a Twitter user yourself, this splashy company, valued at roughly $18 billion before the IPO, may look like a solid investment.
“The fundamental error that people make about the internet is to confuse that which is popular with that which is profitable,” writes Megan McArdle of Bloomberg. Any prospective investor should know, first and foremost, that Twitter does not make a profit. Those buying in are investing in Twitter’s potential.
Let’s look at some stats:
• Twitter has 232 million users worldwide (Facebook has 1.2 billion)
• 89% of Twitter’s revenue comes from advertising and 11% comes from licensing user data
• In 2013, Twitter had revenue of $422 million . . . but $548 million in costs, yielding a $126 million total loss
• Although 77% of Twitter’s users are outside the U.S., non-U.S. sources account for only 26% of the company’s ad dollars
• Potential hurdles include: too few users, too many ads (which could turn off users) and a mismatch between where Twitter’s users are and where its ad money comes from.
• From Twitter’s shareholder correspondence: “The market price of our common stock may be volatile, and you could lose all or part of your investment.”
According to a Wall Street Journal survey, despite the stock’s gangbusters first day, 42% of respondents said they’d value the stock under the IPO price of $26 per share, and despite the stock’s current heights, only 15% of respondents thought that the stock was worth over $40.
Fans of the blue bird argue that Twitter has a lot of room to grow, and its small number of users (compared to giants like Facebook or Google) means that the company will be inspired to make money in new, scrappy, creative ways. All the same, there are a lot of questions about the company’s money-making prospects, and those questions don’t have reassuringly firm answers yet.
Overall, many onlookers are skeptical about the stock’s prospects. The “bottom line” of the Wall Street Journal’s fact sheet leading up to the big day states: “Losses pile up as far as one can see for Twitter.” Not exactly a beacon of hope.
One thing for investors to watch for? Lock-ups, a period of time during which insiders can’t sell their shares. If, for example, all employee stockholders were allowed to sell their shares out of the gate, investors would risk a big drop as those people cashed in all at once. Lock-ups instill a measure of stability. In Twitter’s case, 9.9 million shares held by employees will be eligible for sale starting in February 2014. Not all those people will dump their shares the moment they can—but legally they’re allowed to. Empirically, there’s evidence that after the lock-up period ends, stock prices tend to drop permanently by about 1% to 3%.
Another fine-print factor to think about is dilution. Companies need to pay for good talent, and stock options are a big incentive at tech companies. Of course, that means the total pool of shares today isn’t the same as it will be in a year. By some estimates, Twitter may hand out $430 million in share-based employee compensation in the fiscal year 2014. That’s less than in 2013, but giving stock options to employees could result in 1.5% dilution each year by some projections.
All in All …
As tempting as it sounds to be a master stock-picker, lots of research indicates that most stock-pickers come out worse than if they’d just invested in the broader stock market through an index fund or ETF. Not convinced? Here’s our breakdown on why playing the market will probably lose you money.
Farhad Manjoo of the Wall Street Journal takes LearnVest’s anti-stock-picking attitude even further: “Right now, there are hundreds of stock analysts, market researchers, advertising gurus and other people who are being paid vast sums to determine whether and how much to invest in Twitter. Going against them is a loser’s game, and you shouldn’t play,” he writes. “This is true of all stocks and isn’t specific to Twitter. But there’s a special danger in IPOs, especially big-name tech IPOs, which are governed more by mass hysteria than any kind of rational assessment of long-term potential.”
If you’re itching for a glittering techy vibe to your portfolio, you might consider investing in an ETF or index fund that tracks a technology index like the NASDAQ or the Dow Jones U.S. Technology Index. (Note that Twitter listed on the NYSE, which isn’t a tech-specific index.)
If you’re craving something a little riskier and startup-esque, you might look at the S&P SmallCap 600 Capped Information Technology Index, which includes small- and micro-cap tech companies. Just remember that diversification is key, so you’ll want to make sure that a niche category like this is part of a broader, balanced portfolio.
LearnVest Planning Services is a registered investment adviser and subsidiary of LearnVest, Inc. that provides financial plans for its clients. Information shown is for illustrative purposes only and is not intended as investment advice. Please consult a financial adviser for advice specific to your financial situation.