With the company's stock up 19% since announcing "blowout" third-quarter earnings results on Oct. 26, some may think Twitter (NYSE: TWTR) must be close to righting the ship. For those who follow the tech industry in general, it was hard to miss the headlines.
The headlines went something like this: "Twitter reports renewed user growth." Another popular theme was "Twitter nears profitability," or some derivative thereof. Good tidings or not, Warren Buffett wouldn't touch Twitter stock for several reasons, nor should individual investors.
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Did I hear that right?
One look at Buffett's Berkshire Hathaway portfolio and it's clear he looks for stocks that either are, or have the potential to become, leaders in their respective industries. Other attributes he requires include profitability, a strong management team, and future growth opportunities.
To date, Twitter has exhibited none of the characteristics Buffett looks for.
The renewed user growth Twitter supposedly enjoyed in the third quarter is bordering on ludicrous. Twitter's monthly average users (MAUs) figure, a standard metric for social media providers, was actually terrible given its relatively small user base.
Last quarter Twitter's MAUs grew all of 4% year over year to 330 million. That's not a return to user growth; it's an example of how low expectations for Twitter are. For some perspective, Facebook (NASDAQ: FB) MAUs rose 16% last quarter to 2.07 billion. Considering the disparity in size, Twitter's results are even more distressing.
And it's not just Facebook that is demolishing Twitter in the race for users. Over the last two years, Snapchat (NYSE: SNAP) has added 87 million MAUs, nearly four times Twitter's 23 million. During that same time, Facebook grew its user base 20 times that of Twitter, adding a mind-boggling 461 million MAUs.
"Nearly profitable" sounds nice
Somewhat overlooked in the niceties surrounding Twitter's efforts to turn a profit -- a key factor for Buffett -- was how it went about becoming almost profitable. Unbelievably, Twitter's total revenue of $590 million was a 4% decline compared to a year ago. Worse still, ad sales were a meager $503 million, a stunning 8% drop. Domestic revenue, Twitter's largest market, sank 11% to $332 million.
Though it doesn't seem fair, for comparison's sake Facebook's ad revenue soared 49% last quarter to $10.1 billion, driving a 77% rise in earnings per share (EPS) to $1.59. So with sales dropping, how did Twitter become almost profitable? By taking a machete to expenses, particularly sales-related costs.
Expenses dropped 16% last quarter, equal to $112 million, driven by "decreases in sales and marketing and R&D," which both declined 23%. Sacrificing sales and development overhead today to achieve profitability tomorrow is fine for the near term. But how long can it continue as revenue continues its downward spiral, which is once again expected this quarter?
It starts at the top
The problems Twitter has had retaining key executives is nothing new. The year kicked off with the departure of four senior managers, followed by the CFO over the summer, and the abrupt loss of a key member of Twitter Canada's exec team. Management turnover alone would likely put a screeching halt to any thought Buffett would have to buy Twitter stock.
Perhaps the biggest head-scratcher is CEO Jack Dorsey. Dorsey was adamant he retain his post as CEO of Square when he returned as Twitter CEO two years ago. The Twitter board initially opposed the idea of Dorsey keeping his CEO at Square, but they eventually relented and made Dorsey permanent CEO anyway. Twitter's stock is now near its 52-week high, which is about 50% below its valuation when Dorsey rode back in on his white horse.
Safe to say, Buffett likely wouldn't touch Twitter stock with a 10-foot pole. Dorsey's plan to cut expenses to drive minimal profitability, despite plunging sales, is near-term planning at its worst. Long-term investors would be wise to follow Buffett's lead and run, don't walk, away from Twitter.
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Tim Brugger has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Berkshire Hathaway (B shares), Facebook, and Twitter. The Motley Fool owns shares of Square. The Motley Fool has a disclosure policy.