Twilio (TWLO 1.63%) has done phenomenally well for shareholders since going public, up nearly 800% in the last five years versus the S&P 500 returning "only" 110% during that time period. The stock was even recently picked as the winner in Wall Street's Ira Sohn investing competition, which shows that the smartest people in the industry love this company. But with the stock up so much so quickly, investors are likely worried that they've missed the boat on this high-growth tech stock.
Does Twilio still have millionaire-making potential if held as a long-term stock? Let's find out.
What is Twilio?
Twilio was founded in 2008 and has been the main driver in building out a new industry called communication-platforms-as-a-service, otherwise known as CPaaS. The company builds and manages application programming interfaces (APIs), which are snippets of code that other developers can insert into their own codebase to access high-level tools. These APIs help other developers easily build communication products within their applications like SMS text messaging, video and voice calls, live streaming, and emails.
Twilio makes money in a pay-per-use model. For example, an SMS message costs on average $0.0075 every time an application pings Twilio's API. This allows Twilio to grow alongside its customers, which include large organizations like Lyft and Airbnb.
Outside of these CPaaS services, Twilio is expanding into new product lines. The biggest is coming from its $3.2 billion acquisition of Segment last year. Segment is a customer data platform (CDP) that helps companies manage and understand their customer data. Twilio just announced that Segment's tools will be merging with its communication APIs in a product called Twilio Engage. The product will help companies market to customers with custom messaging and other tools and is a good example of how the company is trying to evolve beyond just communication APIs.
Growth should continue for a while
One big reason Twilio's stock is up 800% is how fast the business is growing. In the second quarter of this year, revenue grew 67% year over year to $669 million, while the company's dollar-based net expansion rate (DBNER) stood at a strong 135%. The DBNER metric highlights Twilio's revenue growth from customers that have been around for more than a year and is similar to the same-store sales metric retailers use. In this case, a DBNER of 135% means that Twilio is seeing 35% revenue growth from existing customers.
Twilio's annual revenue has grown from $650 million in 2018 to $1.8 billion in 2020. And revenue reached $2.3 billion over the last 12 months, a clear sign of how rapidly developers are adopting these tools. With the continued adoption of the cloud and the migration of developers to using APIs, industry researchers are expecting the CPaaS market to grow at 33% a year through 2024. This will be a huge tailwind that Twilio can ride to continue growing this business.
The one thing holding Twilio back
Twilio's business is rock solid, but investors should be concerned about the stock's expensive valuation. At a market cap of $65 billion, Twilio trades at a trailing price-to-sales ratio (P/S) of 26. The company has gross margins of only 51% due to the fees Twilio has to pay to communication networks. This makes the P/S even more expensive because the company will likely never get to the high net profit or cash flow margins of its mature software peers like Autodesk or Adobe.
Could you still make reasonable returns from these prices if Twilio can continue growing revenue at 50%-plus for the foreseeable future? Yes. But if growth slows, multiple compression (i.e. when a company's earnings increase but the stock price doesn't move) is likely to come, which could lead to a lot of downside for Twilio shareholders. This is something you need to weigh before investing in the stock.