Every day, Wall Street analysts upgrade some stocks, downgrade others, and "initiate coverage" on a few more. But do these analysts even know what they're talking about? Today, we're taking one high-profile Wall Street pick and putting it under the microscope...

Confession time: I own Twilio (NYSE:TWLO) stock -- but I'm not entirely comfortable with that.

For one thing, Twilio isn't a profitable company. Despite its shares gaining more than 50% over the past year, Twilio hasn't earned a penny of profit as calculated according to generally accepted accounting principles (GAAP). It's got no free cash flow, either, burning $35 million in cash instead. And by the one measure that you can actually value the company -- sales -- well, the stock sells for more than 16 times trailing sales.

Which seems pretty expensive to me.

Topping it all off, Twilio describes its business as "virtualizing the world's communications infrastructure through APIs" such that "phones, VoIP, and messaging [can] be embedded into web, desktop, and mobile software." Not being a techie, though, I don't really understand how that works in practice, and that...makes me nervous.  

And yet...Twilio is an incredibly popular company. Not only is its stock up 53% in the last 52 weeks, but its sales in the first half of 2018 soared 83% year over year -- and those sales have grown nearly 10 times in the last five years! Which I have to admit, is pretty impressive, and speaks to the popularity of the product.

Wall Street likes Twilio a lot, too, with 22 out of 24 analysts surveyed rating it a buy or the equivalent. This morning, an analyst at investment banker Piper Jaffray assumed coverage of the stock with an overweight rating and a $141 price target.

Here's what you need to know.

Five dice labeled buy and sell on top of LCD screen displaying stock charts and numbers

Image source: Getty Images.

Growth and...

Piper Jaffray breaks down its recommendation of Twilio into three big themes, the first of which is growth. With more than $880 million in trailing-12-month revenue, Twilio is already a force to be reckoned with in the internet communications space.

But the analyst thinks it can be bigger -- maybe a lot bigger. Piper Jaffray expects sales to more than triple in size (to $3.6 billion) by 2024, and under a bull-case scenario, Twilio could surpass $6 billion in annual sales that year -- massive growth in less than five years.

In today's note (as reported by StreetInsider.com), Piper Jaffray points out that at the rate Twilio's sales are accelerating, it's already generating revenue at a "$1B+ run-rate" (i.e., faster than its trailing performance; at current rates, the company should make $1 billion in sales over the next 12 months).

Importantly, though, the "secularly growing" internet communications industry is $66 billion in size already, which means that as big as Twilio has already become, it still owns barely 1.5% of the market. The company is winning more market share, though, and while not yet profitable, says the analyst, it has all the hallmarks of "a profitable share gainer" down the road.

Cash and...

Speaking of profitability, while not yet GAAP profitable, by at least a couple of measures, Twilio isn't far off from turning a profit on its business -- and may even be there already.

Full-year pro forma profits turned positive just last year, for example, and according to estimates collected by S&P Global Market Intelligence, are expected to more than triple over the next two years. Free cash flow -- cash profits -- could turn positive as early as next year (Wall Street estimates $42 million). And over the next several years, Twilio's free cash flow could swell more than 15 times in size to as much as $691 million in 2024, according to analyst consensus estimates.


If analysts are correct about that, Twilio could enjoy 75% compound annual growth in free cash flow over the next five years. Among the "cohort" of software-as-a-service companies enjoying similarly fast (40%-plus) growth rates, Piper Jaffray points out that Twilio's sales multiple -- about 9.7 times analyst estimates for 2020 sales -- compares very favorably to the "average NTM EV/S multiple of 14x."

So how much should such a rapid growth rate be worth to investors? In Piper Jaffray's opinion, at the very least Twilio should go back to $141 a share within a year -- 33% more than it sells for today. Twilio stock thus wouldn't even need to return to its $150 share price of this past July to become a big winner for new investors.

The analyst justifies its $141 price target by assigning a multiple of "34x CY24E EV/FCF," which assuming the consensus estimate of $691 million in 2024 free cash flow is correct, implies a market capitalization of $23.5 billion less than five years from now, or 62% higher than where Twilio trades today.

In the final analysis, therefore, Piper Jaffray's recommendation of Twilio depends on a lot of assumptions: positive free cash flow next year, followed by really incredible growth rates over the next several years, and investor patience and willingness to wait for these numbers to turn positive.

None of these assumptions are set in stone. None of them are certain to happen. But if they turn out to be correct, Twilio stock should be a respectable performer going forward.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.