As has been the case for the past several years, shares of cloud communications company Twilio (NASDAQ:TWLO) have been red hot in 2019. Year-to-date, Twilio stock is up a whopping 60%. Over the past year, it’s up 140%. Over the past two years, the stock is up nearly 400%.
Bears think valuation will short circuit this rally. After all, TWLO stock now trades at 16-times forward sales. That’s rich. But, bears have been saying that valuation will short-circuit this rally for the past two years, during which the forward sales multiple has climbed from 4 to 16, and the stock has risen by nearly five-fold.
In other words, the valuation-focused bear thesis on TWLO stock has been wrong for the past 24 months. Will it miraculously start being right now? No.
The reality is that Twilio stock is a big growth stock with enough growth firepower and a big enough addressable market to warrant a nosebleed multiple immersed in a low-interest rate market that is inflating growth assets. That’s the situation investors have today. In that situation, valuation won’t short circuit the rally in TWLO stock. Instead, TWLO stock will keep grinding higher.
As such, for the foreseeable future, the best move is to remain long TWLO. If rates move higher and/or the company’s growth trajectory starts to flatten out, you will probably want to ditch the stock. But, until those two things appear, the most likely path forward for this stock is higher.
Twilio’s Internal Fundamentals Are Favorable
The first big reason that Twilio stock will remain on a long term uptrend for the foreseeable future is that the company’s internal fundamentals have been, still are, and will remain favorable.
We live in a world of unprecedented connectivity, and the biggest medium of that connectivity is smartphones. Those smartphones are used primarily for real-time communication (think texts, push notifications, and the like).
Consequently, in order to maximize reach and awareness among phone-connected consumers, enterprises have increasingly adopted CPaaS technology, which is essentially real-time communication tools that enable enterprises to reach their customers via messages, voice, and video – think when Uber or Lyft texts you that your ride is close.
Because such forms of communication are becoming more and more important and prevalent, CPaaS is a secular growth market. Twilio is at the head of this secular growth market. As such, the company’s growth profile has been impressive to-date. All boxes have been checked off. Huge revenue growth. Stable and big gross margins. Falling opex rates. Ramping profits.
All those boxes will continue to be checked off for the foreseeable future. The secular tailwinds here will remain in play for a lot longer, because:
1) businesses are increasingly seeking to differentiate their customer experience, and an important element of customer experience is communication; and
2) Twilio has less than 200,000 customer accounts, whereas the U.S. has 30 million-plus businesses, so there’s plenty of runway left in this growth narrative. At the same time, opex rates today are high, and have plenty of room to fall with scale.
Putting all that together, Twilio projects as a huge profit grower for a lot longer. So long as this remains true, TWLO stock should remain on an uptrend.
The Market Backdrop Is Also Favorable
The second big reason that Twilio stock will remain on an uptrend is because the market backdrop is favorable for growth stocks like TWLO.
The biggest thing here is low interest rates. In 2019, the 10-Year Treasury yield has plunged from 2.7%, to 2%, as economic growth globally has cooled, inflation has remained muted, and the Fed has adopted a dovish stance (and may even cut rates soon).
This plunge in fixed income rates has helped support multiple expansion throughout the market (the lower bond yields go, the lower equity yield should go, too). But, low rates have been especially inflationary for growth stocks, since growth stocks derive a majority of their value from “down the road” profits, and the present value of those “down the road” profits goes up as rates go down.
Without a doubt, Twilio stands in the growth stocks bucket. This is a $140 stock with EPS projected at just $0.12 this year. But, 2020 EPS is projected at $0.32. In 2021, EPS is expected to climb to $0.64. Thus, pretty much all of the value underlying TWLO stock comes from “down the road” profits.
From this lens, so long as interest rates remain low, TWLO stock should continue to move higher. With the Fed on the verge of heading into a rate-cutting cycle, rates should remain lower for longer, meaning that the rally in Twilio stock should persist for longer, too.
The Technicals Are Favorable, Too
The third big reason that Twilio stock should remain on an uptrend is because this stock is supported by favorable technical trends.
The current big uptrend in TWLO stock started about 18 months ago, at the beginning of 2018. Ever since, the 50-day moving average has provided a consistent and stable line of support for the stock. Even during the late 2018 market meltdown, TWLO stock only traded a few points below its 50-day moving average.
Right now, that 50-day moving average sits at $137. TWLO stock trades hands at $143. Thus, there’s only about 4% downside potential to what has been this stock’s big and stable line of defense for the past 18 months.
Bottom Line on Twilio Stock
Twilio stock is richly valued. But, it’s been richly valued for a long time, and the stock has ignored that rich valuation because of a combination of big growth fundamentals, favorable market fundamentals, and strong technical trends.
All three of those tailwinds should persist for the foreseeable future, meaning that TWLO stock should continue to defy valuation standards and stay in rally mode.
As of this writing, Luke Lango was long TWLO.