The average consumer may not know Twilio (NYSE:TWLO), but it has become a hit for investors. The San Francisco-based communications platform-as-a-service (CPaaS) company has experienced a stock price increase of about 240% over the last year. Still, while the company's growth points to a long-term value proposition, it also may indicate that investors should wait for a correction in the tech stock before buying.

What is Twilio?

Twilio provides what it calls programmable application program interfaces (APIs) that developers can use to enable activities such as chats with customer support, reminders, and video conferences. 

Consequently, it powers applications such as the rideshares provided by Lyft and the customer communications for Airbnb. Over 190,000 businesses enable almost 932 billion customer interactions per year through Twilio.

Young woman wearing a mask while using a smartphone in a public area.

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Companies such as Microsoft, Avaya, and Cisco compete in the CPaaS market. However, Twilio stands apart through Twilio Flex, which bills itself as "the world's most flexible cloud contact center." Developers can easily change any part of the system and deploy it rapidly.

Twilio also builds an advantage through its Super Network, which simplifies, brings together, and fortifies communications networks. It can measure network quality and route traffic through the network that will provide the best communications links. It utilizes AI to improve its functions, so the more people who use it, the more it learns, and better the Super Network becomes.

In fiscal 2020, Twilio reported a net expansion rate of 137%. This means the company earned 37% more on average from existing clients than the year before, indicating clients' increased dependence on the company.

Effects on Twilio and its stock

Twilio's competitive advantage in a fast-growth industry shows up in its financials. In 2020, its revenue grew by 55% to $1.76 billion.

Nonetheless, Twilio continues to struggle on the profit front. The company lost $491 million in 2020, compared with $307 million in 2019, meaning 60% growth in company losses.

The cost of revenue, meaning the fees to network service providers, and operating expenses rose by 61% and 44%, respectively. Twilio blamed rising revenue costs on several factors, including the global economy and the impact of COVID-19 on its clients.

Additionally, $11.5 million in losses on foreign currency translations worsened overall losses. Twilio also experienced a reduction in the overall income tax benefit from $55.2 million to $13.4 million related to the SendGrid and Segment acquisitions, which occurred in 2019 and 2020 respectively.

Still, investors should understand that cost of revenue, currency, and tax costs vary. Also, the fact that operating expenses are growing more slowly than revenue indicates that Twilio has succeeded in reducing the costs over which it has control. This gives the company a better chance at growing its way to profitability.

Furthermore, Twilio projects a revenue increase of between 44% and 47% for the first quarter of 2021. This outpaces the forecast made by market intelligence company Industry Research, which predicts a compound annual growth rate (CAGR) of 37% for the CPaaS industry through 2025. Hence, both company and industry projections suggest more rapid expansion for Twilio for the foreseeable future.

However, that optimism helped to take its valuation to more than 28 times sales, leading to questions about whether it has become an overvalued growth stock. Until last summer, Twilio stock had never reached a P/S ratio of above 20. One year ago, it had fallen to about 10 times sales as well. Despite Twilio's rapid expansion, the stock may have moved ahead of its fundamentals.

Should I buy Twilio?

Twilio's widening competitive moat and the corresponding rise in revenue point to a bright future for the stock. The company has managed to keep the expenses it can control growing more slowly than revenue.

Nonetheless, the stock trades at near-record valuation. That high P/S ratio appears at a time when and tax expenses increase more quickly than revenue growth. Given that uncertainty, investors should probably wait to buy.

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.