Twilio Stock Unlikely to Rally Much Further Anytime Soon

There are many reasons to like Twilio stock over the long-term, but its near-to-medium term upside will be limited because of its stretched valuation

Twilio Stock Still Going Strong 2 Years Later

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The shares of cloud communications app maker Twilio (NYSE:TWLO) have soared since the company reported robust, double-beat-and-raise third-quarter results which bolstered the stock’s long-term bull thesis. Twilio stock is up about 36% since it reported its results.

That is a huge move. But it also comes in the wake of a big drop in Twilio stock. Between late September and early November, Twilio stock dropped 20%, falling from $88 to $70. Now TWLO stock has recovered those losses, and then some. After this big post-earnings pop, Twilio stock is trading at fresh all-time highs.

Is this a rally worth chasing? Has Twilio stock returned to its winning ways?

TWLO stock is back to its winning ways. But this rally of Twilio stock is not worth chasing at current levels. While the company’s growth outlook is improving and its long-term fundamentals are promising, the current valuation of TWLO stock is stretched. Not by much. But by enough to make investors second- guess buying a stock that jumped around 36% in recent days.

Consequently, while TWLO stock has robust long-term upside, its near-to-medium-term upside will be limited by worries about its valuation.

The Long-Term Fundamentals of Twilio Stock Are Strong

Twilio’s third-quarter numbers were in-line with the long-term bull thesis on TWLO which states that the company is emerging as the leader of one of the market’s biggest growth industries.

Over the past several quarters, Twilio has emerged as the uncontested leader of the rapidly growing and potentially huge Communication Platforms-as-a-Service (CPaaS) market. The CPaaS market, which consists of companies that are integrating real-time communication into their services, will be huge due to continuous shifts towards cloud-based communication, personalized customer experience and digital engagement.

For what it’s worth, research firm IDC expects this market to grow five-fold over the next five years.

With its huge customer and revenue growth and a 95%-plus retention rate, TWLO is the undisputed CPaaS leader. Its third-quarter numbers bolster that thesis. The company’s revenue growth continued to accelerate, reaching 68%, the highest level this year. Meanwhile, its customer growth remained above 30% despite tougher comparisons.

The company’s guidance was also bullish. Its top line is expected to jump by over 65% this quarter, versus the 40% revenue growth it reported for the fourth quarter of 2017.

Broadly speaking, TWLO’s Q3 report showed that it’s the unchallenged CPaaS leader. That is a huge growth market, making TWLO a huge growth company. Investors won’t leave the shares of a huge growth company with strengthening fundamentals depressed for that long, and Twilio stock was 20% off its recent highs heading into the print. In this context, Twilio stock’s 36% spike after its earnings makes a whole bunch of sense.

The Valuation of Twilio Stock Is a Concern

But just because the rally of TWLO stock makes a whole bunch of sense doesn’t mean this rally is worth chasing.

The last time I updated readers on Twilio stock in mid-September, it was near $90, and I offered very simple advice:

…this is a “buy the dip” stock. Eventually, this stock will have a big dip, as all hyper-growth stocks eventually do. I think that will be a dip worth buying. Until then, I think valuation will cap upside potential.

I’m offering the same advice today. Following my mid-September update on TWLO stock, the stock proceeded to fall from $90 to $60 in late October. That was the big dip worth buying. Now the shares are rallying back to all-time highs, and we are back to where we were a few months ago.

Above $90, Twilio stock is simply too richly valued to advance much further in the near-to-medium term. At best, I think that Twilio’s revenues will jump by 500% over the next five years to $2 billion by fiscal 2022. Over the subsequent five years, its revenues will rise by another roughly 20% per year in a best-case scenario to $5 billion by fiscal 2027. During that stretch, I expect the company’s profitability to rise by large amounts, driving its earnings per share to around $7.50 by fiscal 2027.

Twilio’s EPS this year is projected to be just 10 cents.

But even long-term earnings of $7.50 per share aren’t enough to justify a $90-plus price tag for Twilio stock. Mature software companies tend to trade around 20 to 30 times their forward earnings. Let’s assume Twilio stock trades at 25 times its forward earnings in fiscal 2026. Based  on my fiscal 2027 estimated EPS of $7.50, that would imply a fiscal 2026 price target of about $188. Discounted back by 10% per year, that equates to a fiscal 2018 price target of under $90 for Twilio stock.

Thus, prices above $95 seem premature for TWLO stock.

The Bottom Line on Twilio Stock

Twilio stock is a long-term winner powered by continuous growth drivers in the CPaaS market. But the stock’s current valuation fully reflects those long-term growth drivers, and as a result, its near-to-medium appreciation is likely to be limited.

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

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