Twilio (NYSE:TWLO) has been one of the hottest growth stocks over the past two years. It rallied from the low $20s in early 2018 to above $150 this July as it repeatedly dazzled investors with its breakneck sales growth and expanding ecosystem.

However, Twilio's stock subsequently lost about a third of its value after hitting that all-time high, and recently continued its slide after it followed up a solid third-quarter earnings report with weak guidance for the fourth quarter. Does that misstep indicate that Twilio's high-growth days are over?

A woman uses a messaging app on a smartphone.

Image source: Getty Images.

Twilio's formula for success

Twilio's cloud service handles text messages, emails, voice calls, videos, and other content for mobile apps. Developers simply add a few lines of code to their apps (called APIs, or application programming interfaces) to outsource those services to Twilio, which is generally easier and cheaper than building those features from scratch.

Twilio enjoys a first mover's advantage in this niche, and its active customer accounts surged 181% annually to 172,092 at the end of the third quarter. It also expanded by acquiring smaller companies like Beepsend, Ytica, and SendGrid.

Twilio measures its growth in three main ways: its reported revenue, its "base" revenue (which only includes customers that signed 12-month minimum contracts), and its dollar-based net expansion, which measures its sales growth per individual customer. All three metrics remained robust over the past year:

Metric

Q3 2018

Q4 2018

Q1 2019

Q2 2019

Q3 2019

YOY revenue growth

68%

77%

81%

86%

75%

YOY base revenue growth

68%

77%

88%

90%

79%

Dollar-based net expansion rate

145%

147%

146%

140%

132%

YOY = Year-over-year growth. Source: Twilio quarterly reports.

Twilio's growth looks impressive, but it was significantly boosted by the SendGrid acquisition, which closed this February. Its growth is expected to decelerate significantly in fiscal 2020 unless it makes another big acquisition.

Twilio expects its fourth-quarter revenue to rise 52%-54% annually, and for its base revenue to grow 61%-62%. Analysts had expected its base revenue to rise 72%. Twilio attributed that miss to billing errors which resulted in onetime credits being paid to several customers, as well as tough comparisons to the strong political traffic and the ramp-up of a big international customer in the prior year quarter.

For the full year, Twilio expects its revenue to rise 71%-72% with about 78% growth in base revenue. However, Wall Street anticipates just 32% sales growth next year after it fully laps the SendGrid acquisition.

At $100, Twilio trades at about nine times next year's sales, which is a reasonable ratio relative to its sales growth. By comparison, Veeva Systems (NYSE:VEEV) -- another high-growth cloud service player -- trades at nearly 17 times forward sales, but analysts anticipate just 20% sales growth next year.

A cloud of social networking connections.

Image source: Getty Images.

But mind the rising costs...

Twilio's spending is rising as its organic revenue growth decelerates. Its operating expenses more than doubled to $252.8 million in the third quarter as its stock-based compensation expenses more than tripled $197.3 million, or 67% of its total revenue.

As a result, it reported a non-GAAP operating loss of $3.6 million, compared to an operating profit of $4.3 million a year earlier. Its non-GAAP EPS dropped from $0.07 to $0.03, which still beat expectations by two cents. Its GAAP net loss -- which includes stock-based compensation expenses and other charges -- widened significantly from $27.1 million to $87.7 million, or $0.64 per share.

Twilio expects a non-GAAP EPS of $0.01 to $0.02 in the fourth quarter, which misses the consensus forecast of $0.07 by a wide margin. It expects a non-GAAP EPS of $0.12-$0.13 for the full year, which represents growth from $0.11 per share in 2018 but also misses the consensus forecast for the metric.

That soft bottom-line growth raises concerns about rising competition from rival platforms, like Vonage's Nexmo and Bandwidth, as well as first-party solutions from big customers like Uber, which started replacing Twilio's services with its own two years ago.

Wall Street also expects Twilio's non-GAAP earnings to rebound nearly 80% next year as it reins in its operating expenses and laps SendGrid's integration costs. Yet Twilio still lacks a clear path toward GAAP profitability, and it trades at nearly 400 times next year's non-GAAP earnings -- which makes it a tough stock to properly value. Veeva, which is profitable by both GAAP and non-GAAP measures, trades at about 60 times forward earnings.

So is Twilio losing its mojo?

Twilio still has a rock-solid business model and it won't lose its mojo anytime soon, but its stock still looks a bit frothy after its post-earnings plunge. Speculative investors could consider starting a small position here, but I think they should see how it fares throughout fiscal 2020 before accumulating a bigger stake.