What a stellar year 2020 has been so far for the owners of Twilio (NYSE:TWLO) stock. The novel coronavirus means we live in an increasingly interconnected world where businesses need to digitally communicate with their clients non-stop. A forerunner in the communication platform-as-a-service (CPaaS) sector, Twilio benefited from that trend and Twilio stock is up around 145% year-to-date.
Investors now wonder what they can expect from cloud-based communications tools specialist Twilio in the final stretch of the year.
In the long-run, I expect the increased demand in technology to lead to more sales for the cloud communications platform.
However, there is likely to be profit-taking in Twilio stock in the near-future, which may push the shares toward $225.
How Q2 Results Came
Twilio’s cloud communications platform helps businesses improve their digital interactions with their customers. Several of its prominent clients include American Red Cross, Arkansas Children’s Hospital, Coca-Cola (NYSE:KO), eBay (NASDAQ:EBAY), Lyft (NASDAQ:LYFT), Mercado Libre (NASDAQ:MELI), Twitter (NYSE:TWTR), VMware (NYSE:VMW) and Yelp (NASDAQ:YELP).
Earlier in August, San Francisco-based Twilio reported second-quarter results that exceeded the Street’s estimates. Total revenue was $400.8 million, up 46% year-over-year. It delivered net income of $9.5 million, or 71 cents per share.
The company has more than 200,000 active customer accounts, up 24% YOY. CEO Jeff Lawson said, “Organizations in nearly every industry are turning to Twilio as they identify new ways to communicate with their customers and stakeholders. We are just scratching the surface of this huge opportunity, and we believe the solutions being built today using our customer engagement platform will be the standard for digital engagement in the future.”
Following the release of the quarterly results, Twilio stock initially headed lower, possibly on light EPS guidance as well as profit-taking. However, in the second half of August, it recovered most of that loss. Now TWLO shares are hovering around $270.
High Valuation Is a Concern for Twilio Stock
Many analysts agree that Twilio’s best days are possibly ahead. However, Wall Street is also getting concerned about the rich valuation levels of Twilio stock.
Investors may use different metrics to gauge the relative value of companies in different industries. One metric is price-sales (P/S) ratio. The P/S ratio of TWLO stock is over 27.4. Analysts prefer a low P/S ratio, ideally below 1. However, a P/S ratio between 1 and 2 is more common. To put the metric into perspective, the S&P 500 index‘s average P?S is 2.3.
Another way to analyze a stock’s valuation is to compare its valuation to that of other companies in similar industries or segments. In general, SaaS stocks are richly valued. Our readers may be interested to know that the P/S ratio for the cloud computing giant Salesforce.com (NASDAQ:CRM) is 13.1, while Veeva (NASDAQ:VEEV) and Workday (NASDAQ:WDAY), two other SaaS stocks, have P/S ratios of about 36.5 and 14.1, respectively.
Although the P/S ratio of TWLO stock is high, investors should also remember this is only one of many valuation metrics. Moreover, the metric does not take into account the profitability or costs of Twilio.
Twilio is also facing increased competition on multiple fronts from several enterprise software companies, including Salesforce.com and Bandwidth (NASDAQ:BAND). The digital communications revolution is here to stay, but the space TWLO operates in is fiercely competitive.
Where TWLO Stock is Now
Twilio is regarded as a high-growth disruptor. It went public in June 2016 at an opening price of $23.99. By September 2016, the price of Twilio stock was hovering around $70. The shares started 2020 just shy of $100.
By mid-March, TWLO shares were below $70. Now they are around $236. Investors who follow short-term technical charts will be interested to know that Twilio stock is now in overbought territory. It is possible that the recent volatility in tech shares will lead to further profit-taking soon.
TWLO is both a growth and a speculative stock. Therefore, in the coming weeks, I expect Twilio to be a battleground between investors and traders. While long-term investors would like to see TWLO stock exceed and stay over $275, traders are likely to keep it between $225 and $250.
As long as Twilio stock remains in a long-term uptrend, investors may continue to buy it on dips. However, if prolonged profit-taking sends the shares below $225, the validity of the long-term uptrend would need to be reevaluated. And in the wake of such a decline, it may be some months before TWLO stock price sets fresh records.
In the coming quarters, Twilio‘s revenue growth is likely to continue. As a result, the leading provider of in-app communication solutions is setting the bar quite high for its next earnings report. Any sign that Twilio’s growth outlook is not as strong as expected in Q3 or Q4 may be enough to spook investors, sending the share price lower.
Those investors who already own Twilio stock may consider taking some money off the table or hedging their positions. Such a hedge would limit their downside risk in the event the market drops or if the bullish thesis on TWLO stock ends up being wrong.
As for hedging strategies, covered calls or put spreads with Oct. 16 expiration dates could be appropriate. Straight purchases of put options are likely to be expensive due to heightened volatility in tech shares. Investors who choose this route can reevaluate their long positions around the expiry of options.
Well-performing stocks tend to keep on winning, and the recent strength of TWLO shares might be a good indication that within three or four years, investors who buy Twilio stock on weakness are likely to be rewarded handsomely.
On the date of publication, Tezcan Gecgil did not hold (either directly or indirectly) any positions in the securities mentioned in this article.
The author has worked in investment management for over two decades in the U.S. and U.K. In addition to formal higher education in the field, she has also completed all 3 levels of the Chartered Market Technician (CMT) examination. Her passion is for options trading based on technical analysis of fundamentally strong companies. She especially enjoys setting up weekly covered calls for income generation. She also publishes educational articles on long-term investing.