This week Twitter enjoyed a very favourable debut on the publically traded stock market. Unlike Facebook last year, Twitter saw its shares come onto the market at a good price and went on to be valued at $14 billion, many times what it is projected to earn next year ($1 billion). But how do these stock market valuations work? Can Twitter make the sort of amounts that its investors are expecting? We look at the so-called “Twitter bubble” and break it down to its very basic elements.

http://en.wikipedia.org/wiki/File:Dick_Costolo.jpg

Since Twitter was launched in 2006, the micro-blogging service has been building a massive worldwide user base in order to one day launch a more aggressive advertising strategy in order to make revenue. Nowadays, Twitter has grown along with the mobile market. It will be expected to make more of features such as promoted tweets to offer more advertising avenues to brands that use the service, and therefore begin to make some serious revenue. Now that Twitter is a publicly traded company, it can use the money it makes to buy out other companies. It recently bought MoPub, an online ads publisher, back in September of this year. Buying this company allows Twitter more control of the digital advertising market since it is moving beyond tweaking services on its own platform and into the broader paid ads arena.

The sale of shares made money for Goldman Sachs and other underwriters, although a spokesperson for Goldman Sachs was keen to underline that the bank had not orchestrated the share valuation to make money for themselves. Today’s IPO prices are in fact rather modest compared to prices around the time of the dot-com boom. With the recent financial reforms, companies are keen to keep on the right side of fresh law solicitors.

For the uninitiated, a share is an ownership stake. A company wishing to sell shares must make all its financial data public and begin the process at least 6 months before its stock market debut. Valuation is essentially an educated guess made by the bank  that is performing the valuation–this is usually done through a process of calculating assets and shopping the shares around to potential investors. The value of the company shares are then assigned according to the value that investors are prepared to pay for them. However, this is not a perfect process. Notoriously, Facebooks stock did badly on the stock market. Yet a bad stock market debut does not break a company. Facebook shares have now recovered and the company is doing well.

As a result of this weeks financial activity, there are 1,600 and newly created millionaires who are owners of shares in Twitter. Most of these individuals are people who have been involved with the company since its inception–people who have contributed much to making Twitter the service it is today. As for its two cofounders, they are now billionaires. No wonder Dick Costolo was giving celebratory interviews in the New York as Twitter was making its glorious debut on the stock market. Off to a fantastic start, it will be interesting to see whether Twitter is valued at $26 a share in a years time.