Will Twitter Follow Zynga to an 85% Drop?

Behind every new technology is an innovative thinker… someone who creates a product or service unimaginable to those who came before them.

And naturally, the masses are typically skeptical of such new technologies. We’re often slower to see what the innovator sees.

Social media start-ups were no exception when they came online back in the early 2000s.

In those days, chat rooms and message boards populated the Internet. They provided easy communication across distances, but they did little to truly connect webs of people, as Facebook does today.

Today, social media is big business… albeit a business model that is still viewed with a skeptical eye by the folks who analyze traditional performance metrics, like same-store sales growth or profit margins.

When it comes to social media, the conversation regarding a technology’s ability to generate steady profits can be a weird one. It often goes like this:

Social media start-up: “We grew our user base by nine million last quarter!” (true of Twitter.)

Investors: “Great. How much revenue does each user generate?”

Social media start-up: “Huh? Revenue?”

Simply put, it’s often easier to introduce a product that goes viral, attracting many millions of free users, than it is to convert those same users into profits.

Still, that challenge doesn’t prevent social-media titans from taking their technologies to Wall Street. Going public gives them a chance to cash out, turning potential revenue into real cash in their pockets.

While initial public offerings (IPOs) almost always put a smile on the innovator’s face, investors aren’t always as happy with post-IPO results. For example, shares of Facebook (Nasdaq: FB) now trade for 62% more than their IPO price, early investors suffered through losses of more than 50% during the first three months.

For Zynga (Nasdaq: ZNGA), the online social games developer that garnered the attention of millions of Facebook’s users, IPO investors are hating life!

Initially, Zynga’s stock surged 54% higher in the three months following its December 2011 IPO. Then shares plunged 85% over the next eight months. Investors who bought on Day One are still down 53%. Ouch!

This pattern — a big pop, followed by a big drop — is tell-tale of investors’ initial blind euphoria, followed quickly by a return to reality regarding the company’s true prospects. Often, it takes only one quarterly earnings report to wipe the blush off the rose.

This week, Twitter (NYSE: TWTR) made headlines for delivering a disappointing quarterly earnings statement that showed new user growth was lackluster. The company generated earnings of just 2 cents a share, or roughly $1.01 for each of its 241 million active users.

Interestingly, Twitter’s stock has followed the same trajectory as Zynga’s did through the first 60 days following the IPO. Take a look…

See larger image

Twitter and Zynga may ultimately suffer from a business model that is too specific, being focused solely on real-time conversation (Twitter) and online social games (Zynga).

Facebook, on the other hand, has worked to transform itself into a broader social ecosystem, complete with photo-sharing (after its purchase of Instagram) and news feed. A diversified product line gives Facebook the opportunity to attract a larger and more diverse set of users, as well as the potential for multiple revenue streams.

Despite the hecklers, Facebook is now a 10-year-old company, worth more than all but 19 of the S&P’s 500 largest companies.

It’s hard to stomach Facebook’s whopping price-to-earnings ratio (P/E) — now 105, or six times the S&P 500 average — and that’s likely keeping value investors on the sidelines.

But the company is still worth the investment, and one you should look to make.

One way to buy Facebook’s stock, while hedging the frothy price and the possibility of a weak stock market in 2014, is to pair it with a bearish trade on Twitter. Here’s what you do…

  1. Buy Facebook (Nasdaq: FB).
  2. Sell short an equal dollar amount of Twitter (NYSE: TWTR).

This pairs trade should work to mitigate any wild swings — up or down — in the broad stock market. Instead, you’ll be betting that Facebook will outperform Twitter, whether the broad market is up or down.

If Twitter’s stock continues to follow Zynga’s trajectory… this could be a very profitable trade.

Harry Dent’s Most Disturbing Prediction in Years

Harry Dent, one of the most respected economists in the industry, has uncovered a disturbing market event that could soon devastate millions of investors. In short, he has undeniable proof that one of the market’s safest and most popular investments is about to get slaughtered… and it will have dire consequences for those who don’t prepare right away.

For full details on the event Harry’s dubbed as the “Safe-Asset Slaughter”… and to ensure you escape the coming carnage, I urge you to watch this special presentation.

Click to Learn More
Categories: Investing

About Author

Adam O'Dell has one purpose in mind: to find and bring to subscribers investment opportunities that return the maximum profit with the minimum risk. Adam has worked as a Prop Trader for a spot Forex firm. While there, he learned the fundamentals of trading in the world’s largest market. He excelled at trading the volatile currency markets by seeking out low-risk entry points for trades with high profit potential. An MBA graduate and Affiliate Member of the Market Technicians Association, Adam is a lifelong student of the markets. He is editor of our hugely successful trading service, Cycle 9 Alert.