Twitter Stock Soars, But Be Cautious About Buying

Twitter stock soars 90 percent above its original price, likely overinflating its value.

Twitter CEO Dick Costolo gives an interview on the floor of the New York Stock Exchange after Twitter's IPO on Nov. 7, 2013, in New York City.
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Twitter had an exciting first day on Wall Street as its stock price closed at $44.90, well above the original value of $26 set by the social media giant during its initial public offering, but that price is likely to drop as the dust settles on trades for the newly public company.

[READ: Twitter's History Leads to $45.10 Share Price]

Demand for the tech giant (ticker 'TWTR' on the New York Stock Exchange) caused brokers to open trading of the stock at $45, and the stock soared to a high of $50.09, even while prices of other stocks dropped on the Dow Jones Industrial Average, the S&P 500 and the Nasdaq Composite Index.

Everyday investors curious about whether to purchase Twitter should be cautious that the company's revenue and user base are both growing, but it reported a net loss of $79 million in 2012. Social media companies are still developing ways to make money off their users, so investors who bought Twitter stock may dump it for a quick profit rather than wait patiently for the company to develop a revenue plan, says Brian Hamilton, chairman of the Sageworks financial analyst firm.

"The stock might do well in the short term, but the institutional guys have bought the stock and will look to dump it, which is the real risk to the investing public," Hamilton says. "Over time, when the market starts to cool off, companies will be rewarded and punished based on their fundamental financial performance."

Twitter may develop strategies to become profitable by late 2014 or early 2015, using the money it raises from its sale of stock and the line of credit it has with bankers including Goldman Sachs, says Santosh Rao, senior equity analyst and head of research at Greencrest Research financial analysis firm.

[ALSO: Twitter Raises IPO Value to $13.6 Billion]

Many IPOs have a very exuberant opening, so prices for Twitter will fluctuate and likely float downward in the coming weeks as short-sellers, those who profit when a stock declines in value, cash in the stock, Rao predicts.

"The stock will pull back closer to $30. It may take four weeks or six weeks," Rao says.

The social media stock's closing price for Thursday at $44.90 was "way overpriced," but the initial value proposed by Twitter at $26 is a reasonable price, reflecting how Twitter has been working to avoid the missteps of Facebook's IPO in May 2012, Rao says. Facebook faced intense pressure from Wall Street following its IPO over a lack of a clear revenue strategy and investor relations, and the stock slumped before rising above its IPO price in July of 2013. Facebook opened at $42.05 in May 2012 and closed at $47.56 on Thursday.

"Facebook priced it too high, they diluted the stock so much," Rao explains. "Twitter priced it well. Prices were managed well. Expectations were managed well. The whole IPO process was managed well."

Patient investors will eventually reap the most reward from Twitter stock, Rao opines, looking back on the initial skepticism on Google and Amazon stocks, which eventually rose high above their IPO prices.

"People hung in there because they believed in the business model," Rao explains. "Twitter can easily turn profitable down the road."

[MORE: Twitter May Change to Attract Investors]

The challenge for Twitter is how to improve ways to make money while keeping its user experience simple and enjoyable for people. Twitter is betting that the still-growing mobile device market is going to help it develop its user base and advertising traffic, and the real-time user experience of the social network also offers opportunities to attract advertisers. For Twitter to attract advertisers and prove to investors that it can be profitable, it has to answer the great social media question about "what is the most relevant kind of advertisement" for people's daily lives, says John Jackson, a social media analyst at International Data Corporation tech market research firm.

"Twitter is making a big bet that you are going to be tweeting in front of the TV," Jackson says. "Is an advertising dollar better spent there than it is against a Google search query or a Facebook timeline feed? Twitter is going to have to prove to advertisers that it is a better bet than some of the very formidable alternatives out there."