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Why Investors Still Believe In Twitter

Twitter’s earnings results last week knocked 20% off the stock price. Slim sequential monthly active user growth of 3% in the U.S. and 5% overseas, and a decline in overall user engagement, raised questions about how widely used the service can become.

But the most interesting puzzle about the company right now is why investors still have high expectations for the social media darling, despite the weak user growth. Twitter’s forward price-to-earnings ratio, a measure of how fast investors think the company can grow, is a sky-high 253. By comparison, Facebook trades at 38, LinkedIn at 82 and the S&P 500 at 15.

The high valuation isn’t based on expectations for a dramatic uptick in the number of people who Tweet, which many analysts say may ultimately be a smaller bunch than those who use Facebook. Twitter's number of users grew by 30% last year, compared to 2012, and some analysts are predicting that growth rate will slow to around 24% this year. Even if Twitter can maintain 25% year-over-year user growth, it will take the company about seven years to surpass one billion users.

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“Twitter is a more narrow service than Facebook, so it’s hard to see how it evolves and scales,” says Ryan Jacob, Jacob Internet Fund.