After years of anticipation, Twitter finally went public today on the New York Stock Exchange, and nearly doubled from its $26 IPO price after being 30 times oversubscribed<\strong>
While many investors and commentators view Twitter’s heady market debut as a reason for optimism about our economy and entrepreneurial spirit, I view it as a reason for alarm as it is further confirmation of the existence of the dangerous Tech Bubble 2.0 that I am warning about.
Like most other publicly traded Web 2.0 or social media companies, Twitter is extremely overvalued: it now has a lofty $25 billion market capitalization despite accumulating $300 million in losses over the past three years, including a $65 million loss in the most recent quarter.
Taking a cue from the Dot-com bubble’s playbook, investors have resorted to valuing today’s profitless tech companies on a price-to-sales ratio basis, yet even this metric shows that Twitter’s valuation is quite overvalued at 22 times its expected 2014 sales, which is approximately double the multiple carried by Facebook and LinkedIn (which have high multiples in their own right).
Though just over seven years old, Twitter’s unrealistically high market capitalization makes it worth more than long-established companies such as Alcoa, Harley-Davidson, and News Corp, which is the world’s largest media conglomerate company.
Twitter’s market capitalization isn’t much lower than Yahoo!’s $33.74 billion market capitalization, even though Yahoo! is expected to generate $4.43 billion in revenue and $1.5 billion in adjusted earnings in 2013, versus Twitter’s expected 2014 revenues of $950 million and no earnings to speak of until at least 2015.
Though investors are betting that Twitter will grow into its valuation, I strongly believe that they have gotten ahead of themselves and should be assigning a far more conservative valuation to a speculative investment like this.
Even if Twitter becomes a profitable company, most of their future growth is likely already priced into the stock, which means that even the slightest disappointment will send it tumbling.
Twitter’s Crazy Valuation Is A Derivative Of The Stock Bubble
There is a mania for nearly all Web 2.0-related investments right now, and much of it is a product of the overall U.S. stock market bubble that I have been warning about. (Read my recent stock bubble report)
U.S. interest rates have been extremely low since 2008, which is forcing investors out of conservative investments, and into riskier investments such as stocks, which is inflating investment valuations.
As I discussed in great detail in my report, U.S. stock market valuations are currently in bubble territory. A valuation metric called the Shiller P/E Ratio (price to earnings ratio based on average inflation-adjusted earnings from the previous 10 years) shows that U.S. stocks are as overvalued as they were before the most important generational bear markets of the past century, though some of those bear markets occurred in real terms rather than in nominal terms (the bottom chart is the S&P500):
The total U.S. stock market capitalization to GDP ratio, which Warren Buffet described as “probably the best single measure of where valuations stand at any given moment”, clearly shows that stocks are quite overvalued:
Sentiment indicators also show that U.S. stocks are experiencing a bubble. The Volatility Index or VIX is a gauge of investor fear, and indicates buying opportunities in times of fear (readings of 40 and above), and times to be cautious when investors are too complacent (readings under 15). The VIX is indicating that investors are too complacent, which is exactly what happened during the last bubble cycle from 2004 to 2007.
Another sentiment indicator, NYSE margin debt, has soared to levels that marked the peaks of the prior bubbles in 2000 and 2007. This shows that traders so confident in the market’s prospects (a contrarian signal) that they are leveraging their bets with borrowed money, which is further boosting the market by increasing traders’ buying power.
How Twitter’s Bubble Will Pop
The current Web 2.0 craze is undoubtedly another bubble that will end disastrously as all bubbles do. When the current tech bubble pops, I expect the shares of overvalued companies like Twitter, Facebook, and LinkedIn to plunge dramatically, along with a mass wave of tech startup failures. I don’t necessarily expect this bubble to pop immediately, because global central banks are still in full stimulation mode, which has the potential to inflate the overall stock and tech bubble even more during the course of our spurious, bubble-driven economic recovery or Bubblecovery (click on the link to learn more about this concept).
Tech Bubble 2.0 will most likely pop when the overall stock market bubble pops. As I wrote in my stock bubble report, there are two primary scenarios that I foresee leading to the popping of the U.S. stock bubble, but both involve rising interest rates:
Scenario #1: After several more years of the Bubblecovery, The Federal Reserve has a “Mission Accomplished” moment and decides to end QE and eventually increase the Fed Funds rate, which pops the post-2009 bubbles that were created by stimulative monetary conditions in the first place. Rising interest rates are what ended the 2003-2007 Bubblecovery, which led to the Global Financial Crisis.
Scenario #2: The Fed loses control of longer-term interest rates after investors sell their Treasury bond holdings en masse in fear of a sharp decline in the U.S. dollar’s value after years of money printing.
I am very surprised and alarmed by the fact that investors have been so quick to inflate another bubble after the global financial crisis, which shows that they have not learned their lesson and will therefore repeat it