3 Reasons to Buy Twilio, and 1 Reason to Sell

Twilio (TWLO 2.94%) has been one of the top growth stocks of the past five years. The cloud platform company went public at $15 a share in June 2016, opened at nearly $24, and shares currently trade in the $360s.

Many investors are likely wondering if it's too late to buy Twilio's stock after those massive multibagger gains. Let's examine three compelling reasons to buy Twilio -- as well as one reason to sell it -- to decide.

1. A first-mover's advantage

Twilio processes text messages, calls, videos, and other content for mobile apps. Instead of building those features from scratch -- which can be time-consuming, buggy, and difficult to scale -- developers simply add a few lines of code to outsource those features to Twilio's cloud-based platform.

Image source: Getty Images.

That's how Twilio's service connects Lyft's drivers to their passengers, and helps Airbnb's hosts contact their guests. More than 240,000 customers currently use its services, and that figure could keep rising as more app developers integrate more communication tools.

Twilio's first-mover's advantage in this space gives it a tremendous leg up on smaller rivals like MessageBird, Vonage's (VG) Nexmo, and Bandwidth (BAND 3.54%).

2. Robust growth rates

If we examine Twilio's revenue growth and dollar-based net expansion rate (DBNER), which gauges its revenue growth per existing customer, we'll see why its stock price skyrocketed after its IPO.

Source: Twilio. YOY= year-over-year.

Most of Twilio's growth was organic, but it also made big acquisitions -- most notably SendGrid in 2019 and Segment in 2020 -- to boost its revenue and expand its ecosystem with more features.

Twilio expects its revenue to rise 50% to 52% year over year in the third quarter, and analysts anticipate 52% growth for the full year.

3. Sustainable valuations

When Twilio went public, it was valued at nearly $2.4 billion at its closing price of $28.79 on the first day. Many investors likely thought its stock looked expensive at 14 times its 2015 revenue.

Today, Twilio's stock trades at 28 times trailing sales and 18 times next year's sales. The stock looks a little more expensive now, but it's also risen nearly 13 times from its closing price on the first day -- so investors who fretted too much over its initial valuations missed out on some massive gains.

Twilio's stock is also reasonably valued relative to those of other high-growth cloud stocks. Snowflake (SNOW 2.69%), which is expected to generate 92% sales growth this year, trades at nearly 80 times that estimate. Analysts expect CrowdStrike (CRWD 3.63%) to generate 56% sales growth this year, but its stock already trades at nearly 50 times this year's sales.

The one reason to sell Twilio: Its widening losses

Twilio is slightly profitable on a non-GAAP basis, which excludes its stock-based compensation and other one-time expenses, but its net losses are widening on a GAAP basis. At the same time, its number of outstanding shares is rising due to its dependence on stock-based compensation and secondary offerings.

Source: Twilio.

The bulls might claim Twilio's losses will narrow as it reins in its stock-based compensation, and investors should focus on its non-GAAP gross margins for a clearer picture of its pricing power. Unfortunately, that metric has also been slipping over the past two and half years.

Source: Twilio.

That contraction suggests Twilio actually doesn't have that much pricing power, and recent challenges -- especially the new application-to-person (A2P) fees charged by major carriers for each text message -- could exacerbate that pressure and result in even wider losses.

Do Twilio's strengths outweigh its weaknesses?

Twilio's core business is strong and its valuation seems reasonable, but its widening losses, rising share count, and contracting margins are impossible to ignore. Therefore, I'd prefer to stay on the sidelines until Twilio shows some interest in rectifying those three troubling issues.