In early December, cloud communications app maker Twilio Inc (NYSE:TWLO) looked like a dud. TWLO stock drew comparisons from Fitbit Inc (NYSE:FIT) and GoPro Inc (NASDAQ:GPRO) as one off those one-and-done IPO unicorns that jumped big after going public, but has done nothing but fall since.

Those comps never made sense to me. Unlike FIT and GPRO, TWLO has an attractive long-term growth narrative in a secular growth market. Also unlike FIT and GPRO, TWLO has a big opportunity to grow margins and become insanely profitable. Consequently, I said let it fall a little further and then buy TWLO stock.

Oh, how things have changed in two months.

TWLO stock did end up falling to a low of $23. But one huge quarter later and TWLO stock is at $31.

Is there more upside in this name?

I don’t think so. The time to buy TWLO was when it was getting beaten up below $25. Now that it’s at $30, that opportunity is gone and upside is limited in a long-term window.

Big Sentiment Shift Propels TWLO Stock Above Fair Value

Twilio just announced really strong fourth quarter numbers. It was another double beat quarter, including the biggest revenue beat the company has ever had. The company also delivered an above-consensus revenue guide for both the first quarter of 2018 and full-year 2018. Clearly, top-line momentum isn’t slowing all that much.

But it still is slowing. As base revenue has gone from $250 million to $350 million and up, growth has gone from 80% to 50%. Next year, with revenues projected to hit $485 million, base revenue growth is expected to slow to 30%.

Yes, this growth slowdown with revenue scale is natural (it is easier to go from 1 to 2 than 100 to 200), but nonetheless it is something that should be priced in.

The positive part about this slowdown is that it should be nearing an end. Twilio is the king of the cloud communication space. They essentially provide cloud communication solutions for everyone and anyone that matters in this space. And this is a market (cloud-based unified communications and collaboration) that experts project will grow at 16% per year.

Consequently, as TWLO’s growth rate comes down closer to the market growth rate, overall growth rates should stabilize.

All in all, I think TWLO can grow revenues around 25% per year over the next five years. That would imply revenues in fiscal 2022 at $1.2 billion.

Margins aren’t inflecting upward yet. Gross margins actually fell from 57% last year to 55% this year, and are expected to hover around 53% next year. Operating loss, meanwhile, is widening.

But management isn’t focused on growing margins quite yet. They are focused on setting up the business for sustainable long-term growth in a big growth cloud industry, so near-term margin compression isn’t a big issue.

Nonetheless, this quarter and next year’s 53% gross margin level feels like a bottom. We should start to see expansion in 2019. That expansion could be quite big. Management has a long term gross margin target of 60-65% and operating margin target of 20%-plus.

A 20% operating margin seems doable in five years. On $1.2 billion in revenues, that would imply $240 million in operating profits in 2022, which after a 21% tax rate and on presumably 115 million diluted shares, equates to roughly $1.65 in earnings per share.

At that point in time, top-line growth will look like market growth (~16%). Margins should be largely maxed out, but expansion could drive 20% earnings growth.

The market is trading at a price-to-earnings/growth (PEG) ratio of 1.2, so that PEG implies a fair multiple for TWLO stock of 24. A 24 forward multiple on $1.65 earnings implies a 2021 end price target of roughly $40. Discount that back by 10% per year (four years), and you get to a present value of $27.

Bottom Line on TWLO Stock

The time to be buying TWLO stock was when everyone was dour on the name and it was trading below $25.

But now that sentiment has suddenly shifted and the stock is above $30, buying here would be like shooting behind the duck.

I have a feeling that sentiment will normalize on this name in the near future and the stock will drop. I will look to buy that weakness.

As of this writing, Luke Lango did not hold a position in any of the aforementioned securities.