Twilio (TWLO 1.47%) set the stock market on fire in the first half of the year before suddenly losing momentum in early September for no particular reason. Twilio shares have lost nearly a quarter of their value in the past couple of months, severely underperforming the broader Nasdaq 100 index.
It looks like investors have decided to take some money off the table and book profits despite the fact that Twilio has given its full-year outlook a nice boost. The company projects adjusted earnings between $0.17 and $0.18 per share, which is a significant jump over its prior expectation of $0.12 per share.
The stock is now trading at a cheaper level than where it was a couple of months ago. What's more, Twilio projects stronger earnings growth for the year now. Keeping these two points in mind, does it make sense for investors to buy Twilio stock at current levels? Or will it turn out to be a falling knife?
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Why Twilio could be a falling knife
Twilio has seen a rapid decline in a short time but still trades at a really expensive valuation thanks to its terrific rise in the past couple of years.
Its price-to-sales (P/S) ratio of 14 is significantly higher than the industry's median multiple of 2.3, indicating that investors have to pay a large premium for each dollar of Twilio's sales.
The stock doesn't have a trailing price-to-earnings (P/E) ratio because Twilio isn't profitable; there are no earnings to plug into the equation. A forward P/E ratio, based on estimated earnings, of more than 360 indicates that even though it is expected to deliver bottom-line growth, it will continue to remain expensive.
The stock could keep falling, however, savvy investors should take note of a couple of things that indicate Twilio might not be a falling knife.
It is all about perspective
Twilio might seem expensive on its own, but it isn't when compared to similar companies. For instance, identity-security services provider Okta (OKTA -0.69%) has a much higher P/S ratio of almost 26. Furthermore, Okta is not expected to be profitable in the next year, so it has no forward P/E.
There are two reasons why I am comparing Okta and Twilio. First, both companies are software-as-a-service (SaaS) providers, and second, both are growing at a terrific pace. Okta's technology is likely involved when you log in to work-related apps such as Box, Google Drive, or salesforce.com. Similarly, Twilio is probably working in the background when you get a notification that your ridesharing ride is arriving.
The single sign-on login space in which Okta plies its trade is still in its early phases of growth. The market was worth $770 million last year, according to third-party estimates, but is expected to be worth $2.1 billion by 2025. Okta has made a nice dent in this market, as evident from the fact that its revenue jumped nearly 50% in the second quarter of 2019.
So Twilio is not the most expensive, fast-growing cloud stock that money can buy. And more importantly, the company's outlook suggests that it is on track to get better, which is why investors need to look beyond the valuation.
More growth in the cards
Twilio delivered a whopping year-over-year revenue jump of 86% in the second quarter of 2019, including revenue from the acquisition of SendGrid that was completed earlier this year.
The company should be able to sustain this impressive growth rate for a couple of reasons. First, Twilio is making huge strides in the fast-growing cloud-enabled contact center market that puts businesses and customers in touch. According to Mordor Intelligence, this space is expected to clock an annual growth rate of nearly 25% through 2024, when it will be worth $33 billion.
Second, Twilio is in a strong position to gain customers. The company has increased its active customer accounts to nearly 162,000 thanks to SendGrid, which brought 84,000 new customers into Twilio's fold. This means that it now has a bigger pool of customers to whom it can pitch its existing solutions.
If Twilio can successfully tap SendGrid's existing customers and also cross-sell the latter's solutions to its own customer base, it will be able to sustain its impressive top- and bottom-line growth.
So even though Twilio might look like a sitting duck in the event of a broader stock market decline thanks to its valuation, savvy investors shouldn't ignore the company's long-term prospects and its cheaper valuation.
