The premium on Twilio (NYSE:TWLO) continues to increasingly draw attention. Despite warnings about valuation coming from multiple quarters, Twilio stock has recovered quickly from all of its temporary pullbacks over the last 16 months. Consequently, this has taken TWLO stock to multiples that worry investors not typically concerned with value.
With any path to higher stock prices becoming more unpredictable, investors should avoid this equity for now.
Trading on Vision Premium
Twilio has come to dominate the platform-as-a-service (PaaS) market. Given that so many mobile apps rely on the company’s product, the company appears poised to become one of the more essential tech firms. The upshot is that Twilio stock trades with what I call a “vision premium” — that is, companies that bring cutting-edge technologies and trade on potential future earnings rather than the multiples of today.
Twilio’s vision premium has taken its forward price-to-earnings (PE) to an astronomical 437 times earnings. As a result, both my InvestorPlace peers and I have cautioned traders not to buy at these levels.
Admittedly, Twilio dominates the PaaS niche. Also, the fact that Twilio stock has become very expensive will not necessarily take the shares down. Amazon (NASDAQ:AMZN) and Netflix (NASDAQ:NFLX) moved higher for years despite supporting triple-digit PE ratios at times.
My colleague Bret Kenwell calls TWLO stock a “buy on any pullback.” He points to several instances where buying at near-term bottoms led to massive profits. This thesis may continue to prove correct.
Voting, Weighing and Twilio Stock
Unfortunately, when a stock trades well into triple-digit multiples, “predicting” begins and ends with the limits of charting. Moreover, when looking at this, I find myself turning to a quote from Warren Buffett’s mentor, Benjamin Graham.
“In the short run, the market is a voting machine, but in the long run, it is a weighing machine.”
The “weighty” factors which could affect Twilio stock extend beyond the fact that TWLO trades at about 23.4x sales and more than 28x its book value. We also trade in the 11th year of a bull market, making a stock selloff more likely. With no fundamentals to support its value, Twilio might bear the brunt of such a downturn.
Also, traders should consider the history of past tech leaders. Cisco (NASDAQ:CSCO) lost about 90% of its value after becoming one of the more popular tech equities of the dot-com boom. Assuming a company survives such a stock loss, the effects of these high valuations can also last for decades. Cisco still has not recovered its 2000 high more than 19 years after the dot-com bubble reached its peak. Many high-flying tech stocks have and will continue to face similar situations.
Competitive Threats Remain
Moreover, while Twilio has become the dominant PaaS company, competitors such as Zendesk (NYSE:ZEN) and RingCentral (NYSE:RNG) do exist. These PaaS providers hurt Twilio stock last year when Uber announced that they would look at other PaaS companies. Twilio stock recovered when the company expanded its product and service offerings. However, TWLO could face further trouble if large, deep-pocketed cloud companies such as Microsoft (NASDAQ:MSFT) or Amazon decide to compete in this space.
As things stand now, Twilio stock trades at about 9.6% below its 52-week high. A move higher remains possible. Still, considering its situation, I see more factors that could bring about a pullback than inspire a recovery.
Bottom Line on Twilio Stock
Twilio stock lacks a predictable path to further share price increases in the near term. Given that valuation has not influenced the price of TWLO, it could rise from these levels. For now, TWLO stock commands a vision premium, and the likelihood that it will dominate this up-and-coming industry drives this stock for now. Still, at some point, valuation matters. With forward PE ratios well into the triple digits, TWLO appears more likely to attract more weight than votes.
As of this writing, Will Healy did not hold a position in any of the aforementioned stocks. You can follow Will on Twitter at @HealyWriting.