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Should You Buy Twitter After its Post-Earnings Pop?

Shares of Twitter (NYSE: TWTR) recently surged more than 25% after the struggling social network's third quarter revenue and earnings topped analyst expectations. But even after the big bounce, Twitter remains below its IPO price of $26 -- which it hasn't touched in two years.

Investors also remain divided about Twitter's long-term outlook, with the bulls seeing an inflection point and the bears expecting a brief bounce before a nastier decline. Let's take a closer look at Twitter's third quarter to see which argument makes more sense.

Twitter's mobile app. Image source: Google Play.

What Twitter bulls believe

Twitter's non-GAAP net income rose 28% annually to $78 million, or $0.10 per share, which beat analyst expectations by three cents. Its adjusted EBITDA also rose 14% to $207 million, and its adjusted EBITDA margin improved six percentage points to 35%.

But more importantly, Twitter's GAAP net loss -- which includes the stock-based compensation (SBC) expenses excluded from its non-GAAP numbers -- narrowed from $103 million to just $21 million. Twitter reduced its SBC expenses by 36% annually to $101 million during the quarter, marking its fifth straight quarter of SBC expense reductions.

That's why the bulls think Twitter could post its first quarter of GAAP profitability soon. However, these bottom line improvements weren't that surprising, since Twitter already laid off hundreds of workers, shuttered weaker businesses, and sold off other units over the past two years to cut costs.

Many bulls think that Twitter's recent promises to boot bullies, trolls, and certain bots off its network could make its platform more attractive to users and advertisers again. Some bulls also believe that President Trump's incessant tweeting, for better or worse, attracts new users.

What Twitter bears believe

The bears will point out that although Twitter's bottom line has improved, its revenue growth remains weak. Its revenue fell 4% annually to $590 million, marking its third straight quarter of year-over-year declines. Its US revenue also fell 11% annually last quarter, indicating that the presence of Trump on Twitter didn't guarantee strong ad sales.

Image source: Getty Images.

Twitter's total advertising revenues fell 8% annually to $503 million, with cost per engagement falling 54% even as total ad engagements nearly doubled. Simply put, Twitter slashed its ad prices to win back advertisers, but a higher number of cheaper ads purchased still generated less revenue than a lower number of pricier ads in the prior year quarter. Twitter's data licensing revenue rose 22% to $87 million, but that gain was completely offset by its drop in advertising revenues.

Twitter's monthly active users (MAUs) also rose just 4% annually to 330 million during the quarter. That's down from 5% growth in the second quarter, and equals just two million new MAUs added during the quarter. Twitter also gains more users at only a slightly faster pace than it loses older users -- indicating that the platform isn't keeping users interested.

Those numbers look awful compared to Facebook (NASDAQ: FB), which grew its MAUs by 17% annually to 2.01 billion in the third quarter with 47% growth in ad revenues. Facebook also doesn't slash prices on its ads to generate higher volume -- it intentionally throttles the number of available ad slots to boost prices.

To top it all off, Twitter CEO Jack Dorsey is also still the CEO of Square (NYSE: SQ), and the company has done little to stem its ongoing exodus of key executives. This indicates that Twitter could still struggle to develop compelling new products for users and advertisers.

The bottom line: Don't buy Twitter

Twitter's problems are far from over, and investors shouldn't be fooled by a few bottom line improvements that came from some very harsh cuts. Declining ad revenues and sluggish MAU growth will continue weighing down its top line growth, and Twitter could need to lay off more staff or sell other units (like data licensing) to keep narrowing its GAAP losses.

However, cutting costs only goes so far, and Twitter will eventually need to report top line growth, since the stock isn't cheap at six times sales. If it fails to do so over the next few quarters, it could quickly give up its gains -- so investors should steer clear of Twitter for now.

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Leo Sun has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Facebook and Twitter. The Motley Fool owns shares of Square. The Motley Fool has a disclosure policy.