Is Wall Street Getting Too Bullish on Twilio?

Shares of Twilio (TWLO 1.08%) more than tripled over the past 12 months, as the cloud services provider dazzled investors with its accelerating sales growth and improving profits. Some investors might be wary about buying Twilio after that massive rally, but Goldman Sachs recently gave it a buy rating with a Street-high price target of $150 -- which is roughly 15% above its price as of this writing.

Meanwhile, Morgan Stanley rated Twilio as equal weight with a price target of $130, noting that while it could "disrupt an industry ripe for disruption," its potential gains were already baked into the stock. Wall Street analysts currently have an average price target of $123 on the stock.

Image source: Getty Images.

Investors should always be skeptical of analysts' ratings and do their own research. However, we should still take a moment to see if Twilio's stock has gotten ahead of itself, and whether Wall Street is too bullish on its growth prospects.

Check out the latest earnings call transcript for Twilio.

Why Wall Street loves Twilio

Twilio's cloud-based service handles text messages, emails, calls, videos, and other content for mobile apps. In the past, developers needed to create those features from scratch, which was buggy, time consuming, and tough to scale. With Twilio, developers simply add a few lines of code to outsource those features to Twilio's cloud platform -- which can be easily scaled as an app attracts more users.

Twilio enjoys a first mover's advantage in this market, and it's generating accelerating sales growth over the past year. Its base revenue (from customers who signed 12-month minimum contracts) and its dollar-based net expansion rate (its sales growth per customer) also remained robust:

Data source: Twilio quarterly reports. YOY = year over year.

Wall Street loves Twilio's accelerating sales growth, and its three consecutive quarters of non-GAAP profitability indicate that its growth is sustainable.

Analysts expect Twilio's revenue to rise 66% this year, and its non-GAAP earnings to dip 9% to $0.10 per share. In 2020, they expect its revenue and earnings to rise 32% and 160%, respectively, after it laps the SendGrid acquisition. Over the next five years, they expect Twilio's non-GAAP earnings to grow at an average rate of 37% per year.

Image source: Getty Images.

But mind the valuations

Twilio's growth looks impressive, but its valuation is high. At $130, it trades at 1,300 times this year's earnings and about 500 times next year's earnings. That forward P/E is lofty relative to the forward valuations of comparable high-growth cloud service companies like Salesforce (CRM -0.18%) and Workday (WDAY -0.42%):

Data source: Yahoo! Finance, March 19. EPS = earnings per share.

However, five-year forecasts for tech companies can be inaccurate due to disruption and competition, and the bulls will argue that sales growth matters much more than earnings growth for younger tech companies like Twilio. In that regard, Twilio's stock doesn't look that pricey relative to its projected sales growth:

Data source: Yahoo! Finance, March 19.

Is too much growth priced in?

Twilio is hard to value because it's tough to gauge how much growth is baked in. I think it will be tough for Twilio to deliver multibagger returns again from these levels, especially as competitors like Vonage's Nexmo and Bandwidth ramp up their alternative platforms. Twilio's GAAP losses are also still widening and its free cash flow remains negative.

I admire Twilio's business model, but I think Goldman's $150 price target is too bullish. This stock needs to cool off before it moves forward again, and I agree with Morgan Stanley's assessment that much of its potential growth is already priced in.