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Avoid Twilio Stock Until Its Valuation Falls Below the Clouds

Twilio stock - Avoid Twilio Stock Until Its Valuation Falls Below the Clouds

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After seeing a brief decline, Twilio (NYSE:TWLO) stock has again begun to achieve new record highs. Twilio stock quickly recovered from the recent tech bear market that hit most of its peers. As a result, it has seen its value more than quadruple from its January lows.

This has led to its valuation going to stratospheric highs. Although Twilio’s ability to acquire and hold key clients assures its bright future, I would caution prospective buyers not to open positions at these levels.

Twilio Should Continue to Prosper

Admittedly, I made a bad call on Twilio stock early this year. Having been burned by tech booms in decades past, I became more of a value investor. As such, I did not foresee Wall Street’s “do no wrong” attitude that the market currently holds on all things cloud. Certainly, TWLO stock has done little wrong in 2018 as it has risen by nearly fourfold.

I also overestimated the competitive threat posed by the likes of Cisco (NASDAQ:CSCO). While the technology offers little protection from competition at first glance, TWLO’s first mover advantage forms a moat. Twilio’s customers include not only Uber, but also the likes of Netflix (NASDAQ:NFLX), salesforce (NYSE:CRM) and Oracle (NYSE:ORCL). Without Twilio’s technology, these companies die and even brief service outages cause deep pain. Hence, companies hold a compelling incentive to stay with Twilio unless the quality of service falls to intolerable levels.

Valuations on Twilio Stock Have Risen too High

However, the sheer magnitude of this year’s growth and the company’s profit levels force me to hold to the bearish position. For one, a forward price-to-earnings (P/E) ratio approaching 600 should give investors pause. Even my InvestorPlace colleagues who have less of a value orientation have taken notice of the multiple. Laura Hoy describes Twilio stock as “too expensive at current levels.” Dana Blankenhorn pointed out that it trades at more than 10 times revenue.

Luke Lango took things a step further. He described its overvaluation with a discounted cash flow model taken 10 years into the future. I agree with his analysis. However, if one has to take discounted cash flows that far into the future in hopes of building a buy case, that in itself should serve as a sign to avoid the stock.

TWLO Stock Will Perform Longer Term

To be sure, the long-term future of Twilio stock looks bright. I believe TWLO will remain a leading equity in the platform-as-a-service (PaaS) sector of the cloud. I also agree that TWLO stock will likely trade above current levels 10 years from now. Even with its elevated stock price, I expect TWLO to greatly exceed its current $9.7 billion market cap at some point. Also, its expected 157.9% profit growth for this year and 45.5% growth forecasted next year means that Twilio stock investors should not expect a low multiple anytime soon.

However, this does not go so far as to justify a 600 forward P/E. Even if profits explained such a multiple, it leaves little room for near-term upside. With the stock approaching record highs, more can go wrong than right for Twilio stock at this time.

Final Thoughts on Twilio Stock

The outrageous multiple of Twilio stock should serve as a warning to avoid this equity. To be sure, Twilio moved quickly to acquire important PaaS clients early. Since these companies like Twilio’s service, they are less likely to risk costly service outages by trying to make a change. Moreover, the company continues to enjoy massive profit growth. That by itself should take the stock price higher in future years.

However, even the most valuable assets hold only so much value. At about 600 times forward earnings, Twilio stock has moved years ahead of itself. I do not necessarily dispute the advice to buy TWLO on a dip. Still, with an earnings multiple higher than the cloud, I would wait for the P/E ratio to fall closer to Earth.

As of this writing, Will Healy did not hold a position in any of the aforementioned securities. You can follow Will on Twitter at @HealyWriting.

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