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A Top Growth Stock You Might Want to Buy Right Now

By Harsh Chauhan - Nov 12, 2019 at 8:49AM

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This cloud communications specialist has taken a beating in the past few months, but there's more to it than meets the eye.

Twilio ( TWLO -2.41% ) looked like a top growth stock at the beginning of 2019. The cloud communications specialist had delivered terrific gains last year and looked all set to do better this year thanks to its rapid pace of growth.

Twilio stock lived up to its billing in the first half of 2019, but the chart below shows that it has lost its mojo of late.

TWLO Chart

TWLO data by YCharts.

But why has Twilio fallen from grace all of a sudden? Have investors lost confidence in the company's ability to keep growing at breakneck speed? Let's find out.

Twilio makes the wrong noises

Twilio has given investors a couple of shocks over the past few days. First, the company's fiscal fourth-quarter guidance missed Wall Street's expectations by a big margin. And if that wasn't enough, management admitted a few days later that it had made a "simple math error" while calculating guidance.

According to Twilio's "corrected" fiscal 2019 guidance, the company could earn between $0.12 and $0.13 per share this year. That's a downgrade from the earlier earnings-per-share guidance of $0.16 to $0.17 that was issued with the company's third-quarter earnings report. The new earnings guidance is also below the 2019 consensus EPS estimate of $0.14.

Twilio's stock price crash starts making sense in light of these developments. The company needed to deliver mind-numbing guidance to regain confidence, but it did the exact opposite and got punished. However, savvy investors looking for a cheap, fast-growing cloud computing stock are now in luck, as Twilio's long-term story remains intact despite the recent missteps.

A die with buy, sell, and hold written on three sides.

Image Source: Getty Images

The short-term hiccups shouldn't matter

Twilio enjoyed 75% annual revenue growth in the third quarter, including revenue from the SendGrid acquisition. However, the fourth-quarter revenue guidance of $313 million and earnings per share guidance of $0.02 turned out to be disappointing. Analysts were expecting Twilio to deliver $0.07 per share in earnings on $322 million in revenue.

But that's not going to happen for one reason. Twilio's business got a nice 10% bump in the fourth quarter of 2018 thanks to "strong political traffic in the ramp of a large international customer." The company won't be enjoying that one-time gain this time around, and that explains the guidance miss.

Billing errors also caused a revenue loss for Twilio. The company wrongly issued $5 million in one-time credits to customers, which impacted its revenue growth rate. In all, Twilio was prey to a clutch of errors last quarter. But if we look beyond those hiccups, there was a lot to like in its latest quarterly report.

For instance, Twilio's dollar-based net expansion rate jumped 132% in the third quarter. This metric goes north when the company's active customers increase their use of Twilio's services or buy a new product from the company. So the dollar-based net expansion rate measures the sales growth Twilio is recording for each customer.

The good part: This metric has been growing at a healthy pace over the past few quarters, indicating that the company has been able to successfully get more business out of its clients.

What's more, Twilio's growth is being driven by a larger pool of customers. It exited the third quarter with 172,000 active customer accounts as compared to 62,000 accounts in the prior-year period. SendGrid accounted for the majority of that customer growth as it brought 84,000 new accounts into Twilio's fold.

The company's top 10 active customers accounted for just 13% of the total revenue last quarter as compared to 18% in the year-ago period. This combination of a larger, diversified customer base bodes well for Twilio in the long run as more and more customers are signing long-term contracts with the company.

That's evident from the fact that Twilio's base revenue increased 79% in the third quarter, as compared to 68% in the year-ago period thanks to the inclusion of SendGrid. Base revenue includes revenue from those customer accounts that have entered into a 12-month minimum revenue contract.

So, barring a few short-term hiccups, Twilio made the right moves last quarter. The long-term picture remains intact for Twilio, as it is going after fast-growing markets such as email marketing and platform-based cloud communications.

Is now a good time to buy?

Twilio stock is definitely not cheap, but that's expected from a company that's growing at a breathtaking speed. The company needs to sustain its terrific growth rates to justify a forward price-to-earnings ratio of over 320. The fourth-quarter guidance doesn't help in that regard as Twilio now projects annual revenue growth of around 54% this quarter, down from the 77% annual growth it delivered in the same period last year.

However, as we saw above, Twilio's problems seem temporary in nature and its metrics indicate that the company is not yet done growing. What's more, Twilio's price-to-sales ratio of 11 makes it a bargain when compared to the 15 times multiple it was trading at in 2018.

TWLO PS Ratio (TTM) Chart

TWLO PS Ratio (TTM) data by YCharts.

Analyst estimates compiled by Yahoo! Finance point toward a sharp jump in Twilio's earnings in fiscal 2020. If Twilio hits those projections thanks to its diversified, fast-growing customer base and lucrative end markets, buying the stock right now could prove to be a bargain.

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.

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