I often talk about “vision premiums,” or elevated valuations that are given to hot stocks. At this time, arguably no equity defines that premium better than Twilio (NYSE:TWLO) stock.
Bolstered by the leadership status of TWLO’s communication platform-as-a-service (CPaaS), Twilio stock has climbed to elevated valuations amid the company’s massive growth. However, the expensiveness of both the company’s service and Twilio stock could drive its customers and investors to alternative options.
Investors Continue to Ignore the Sky-High Multiple on Twilio Stock
First, I will point out that a stock can stay “expensive” from a price-earnings (PE) ratio standpoint for a long time. This is especially true when a firm seen as the company of the future launches new technologies or lines of business. Amazon (NASDAQ:AMZN), Netflix (NASDAQ:NFLX), and many cannabis stocks have proven that point over the last few years.
However, once a stock has reached such levels, buying it becomes a bet that somebody will willingly pay more in the future. The higher the multiple, the less likely one is to find such a buyer.
Expensive stocks sometimes keep moving higher. That pattern could play out with Twilio stock, which has risen by about 575% since December 2017. However, given Twilio stock’s forward PE ratio of over 490, that is not a bet I endorse.
Profit Deceleration, Competition Could Weigh on the Valuation of Twilio Stock
TWLO’s profit growth, while impressive in a general sense, appears meager when compared to the multiple of TWLO stock. Headwinds will limit its profit growth to an estimated 9.1% this year. Things should improve next year, as its earnings will jump 141.7%, according to the consensus estimate. Still, that level of growth should also prove to be temporary, as analysts foresee average annual growth of 33.2% per year for the subsequent five years.
Moreover, Twilio stock no longer remains the only CPaaS name that investors can buy. Bandwidth Inc. (NASDAQ:BAND) launched its IPO last year. It trades at only 8.2 times its sales, compared to more than 25 times sales for TWLO.
Investors can also choose a much safer CPaaS stock. As InvestorPlace columnist James Brumley pointed out, Cisco (NASDAQ:CSCO) has begun to compete in this business. CSCO’s $34.64 billion cash hoard will allow it to easily outspend Twilio. CSCO’s profit is growing at a double-digit percentage rate, and CSCO stock has a forward PE, based on the consensus EPS outlook, of only 16.5.
Twilio’s Services Are Also Perceived as Pricey
Moreover, the prices that Twilio charges for its services have become too expensive for some.
Unfortunately for the company, the CPaaS industry has a low barrier to entry, and lesser-known peers have hurt TWLO in the past. Investors hammered Twilio stock in 2017 when Uber (NYSE:UBER) moved to reduce its dependence on the company.
Given the strong growth of CPaaS,I do not think increased competition will lead to an overall reduction in Twilio’s customer base or revenues. However, new entrants — particularly an established, profitable entrant such as Cisco — could slow Twilio’s growth and will likely create pricing pressure.
The Bottom Line on Twilio Stock
Although Twilio stock can deliver much of the massive growth it promises, investors and customers who find Twilio too expensive can turn to lower-cost options. TWLO stock has benefited from the company’s leading position in the CPaaS industry. It may even exceed analysts’ consensus revenue growth projection of 70% for the current fiscal year.
However, with Twilio stock trading at over 490 times its earnings, this cloud company has moved into the stratosphere. Also, large customers have shown a willingness to abandon the platform. The company faces competition from upstarts such as Bandwidth and well-funded, established tech companies such as Cisco. Even in a world where PE ratios don’t matter much, TWLO stock is more likely a sell than a buy under these conditions.
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.