Why Twitter, Inc. Stock Dropped Today

By Markets Fool.com

Although we don't believe in timing the market or panicking over market movements, we do like to keep an eye on big changes -- just in case they're material to our investing thesis.

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What's happening: Shares of social networking veteran Twitter fell as much as 14.3% in Wednesday's morning action. Last night, the stock rose as much as 12% in after-hours action on a strong second-quarter earnings report, but those gains evaporated and turned into a full-scale rout during management's conference call with analysts, where Twitter painted a much bleaker picture of its future. By noon Wednesday, the stock was down 12.6% from its previous close.

Why it's happening: In the second quarter, Twitter's revenues rose 61% year-over-year, easily beating both the company's official guidance and analyst projections. If not for currency headwinds, sales would have increased by 68%. Adjusted earnings more than tripled to $0.07 per share, ahead of Wall Street's $0.04 target.

However, Twitter's monthly active users only increased 15% over the year-ago period. The company added 8 million active users in the quarter, but 6 million of these were so-called "SMS fast followers" who only interact with Twitter via SMS text messaging. This is a relatively new distinction, initially seen as a way to boost active user counts. These days, investors are increasingly wondering exactly how Twitter intends to monetize these users, not to mention holding on to them over time.

Image source: Twitter.

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The official revenue guidance for the next quarter came in a bit light, but the full-year sales view exceeded current analyst projections. The company didn't offer bottom-line earnings guidance.

In the earnings call, Twitter CFO Anthony Noto noted that the company "did not see organic growth, positive seasonality or growth initiatives" in the second quarter. Hence, active user growth came in below expectations, and Twitter is knee-deep in figuring out how to spark a return to strong user growth.

According to Noto, Twitter has achieved 95% brand awareness in its core target markets, but only 30% user penetration.

"This low level of penetration implies that we have only reached early adopters and technology enthusiasts and we have not yet reached the next cohort of users known as the mass market," Noto said. If Twitter never reaches across that divide, the company would become an eternal niche player -- a household brand that almost nobody actually uses.

In Noto's view, Twitter has failed to communicate the "unique value" of its services, making outsiders ask why they should use Twitter at all. Correcting this issue is now of critical importance, and Twitter must map a route into the mass market as soon as possible.

The lack of a clear way to do this is scaring investors and analysts. "There's nowhere to hide anymore," said Citigroup analyst Mark May in a televised report, referring to the lack of obvious user acquisition drivers.

The article Why Twitter, Inc. Stock Dropped Today originally appeared on Fool.com.

Anders Bylund has no position in any stocks mentioned. The Motley Fool recommends and owns shares of Twitter. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.