Read This Before Selling Twitter Stock

By Markets Fool.com

Twitter (NYSE: TWTR) stock has delivered dismal returns for investors over the past several years. Shares of the short-message social network were trading as high of as $70 per share in December 2013, and they're currently in the neighborhood of $17.60 per unit. However, there are reasons to believe the market is overreacting to Twitter's problems, which could be creating a buying opportunity for contrarian investors.

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The problems

Twitter isn't growing as rapidly as it could, or should. Many potential users find the platform too complex and intimidating, or they simply don't understand why they should have a Twitter account. The company ended the third quarter of 2016 with 317 million monthly users, an annual increase of only 3%. Facebook (NASDAQ: FB), on the other hand, has a much larger base of 1.79 billion monthly users, growing by 16% year over year in the third quarter.

Image source: Twitter.

Management is making all kinds of moves to accelerate growth, but the results aren't visible yet. The lack of movement is generating considerable turmoil among the company's management team, and Twitter recently explored the possibility of being purchased by a bigger corporation, but those initiatives went nowhere. In this context, there's plenty of speculation about the company's future, or lack of thereof. Over the past several months, many important publications have been wondering if Twitter is doomed, going out of business, or simply dying.

When analyzing investment decisions, investors need to consider not only the company's potential performance but also the expectations incorporated into its current valuation. The bar is certainly quite low for Twitter, and low expectations are relatively easy to beat.

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The opportunity

The business is facing considerable difficulties, but the product is still irreplaceable. Twitter is playing a key role in the U.S. presidential election, providing a platform for candidates and their teams to communicate directly with voters. When it comes to following the debates, fact-checking, or simply creating memes and having fun, Twitter is the go-to social media platform.

Image source: Twitter userShon (@inkedtater).

Management is increasingly focusing on news coverage, an area where Twitter is particularly strong because of its real-time nature. In the words of CEO Jack Dorsey:

We are focused on building the most useful, open, and comprehensive news network on the planet. ... We've been making hundreds of small changes as quickly as we can that will continue to compound in more usage. The people are showing us that these changes are working. We're seeing more people wanting to use Twitter, and to use it more often.

When it comes to the company's financial survival, the reports on Twitter's death are greatly exaggerated. Revenue during the third quarter amounted to $616 million, an 8% increase versus the same quarter in 2015. Twitter clearly needs to do much better in terms of sales growth, but it's not as if revenue is declining. The business is generating positive free cash flow, and management intends to produce GAAP profits next year.

Online advertising is one of the most promising growth industries in the world, and Twitter has significant room to gain market share. According to Wall Street estimates, Twitter will make $2.55 billion in revenue during 2016, while Facebook is forecasted to generate $27.17 billion in sales, and Alphabet (NASDAQ: GOOG) (NASDAQ: GOOGL) is expected to bring in $89.9 billion in revenue during the current year.

Image source: Twitter.

The market for online advertising will continue increasing. eMarketer estimates that digital advertising in the U.S. will reach $77.37 billion in 2017, surpassing TV advertising spending for the first time in history, and that by 2020, the U.S. online advertising market will be worth $105.2 billion. Twitter, for its part, is still minuscule in comparison with industry juggernauts such as Facebook and Alphabet, so the company has plenty of potential to enlarge its share of the market if it plays its cards well.

Twitter does face significant problems, though, and it needs to jump-start user growth to better capitalize on its long-term opportunities. However, Twitter is still a tremendously powerful platform with abundant potential in areas such as real-time events and news. There's plenty of negativity currently priced into Twitter stock, and those who believe Twitter is inevitably doomed as a product or as a business are missing the big picture.

A position in Twitter stock is only adequate for investors with a long-term horizon and an above-average tolerance to uncertainty. However, for those who willing to withstand the risks, Twitter stock could offer attractive upside potential from current price levels.

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Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Andrs Cardenal owns shares of Alphabet (A shares) and Alphabet (C shares). The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), Facebook, and 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.