The stock market's reaction to a company's earnings does not always reflect what's actually in the earnings report. In some cases, investors expected more and when the business doesn't deliver, they head for the exits. Other times, the reported earnings justify a stock's recent price movement and shares continue moving up and to the right.
This most recent quarter, Twilio (TWLO +3.45%) stock was a victim of the first description above and EPAM Systems (EPAM 1.54%) illustrates the latter description.
Overall, both companies reported strong results, but the market's reactions were quite different. Let's look at why these two stocks might be buys, regardless of the initial market reaction to an earnings report.
Image source: Getty Images.
1. Twilio
Communicating with customers is vital for businesses, but it can also be complex. Twilio simplifies this process by providing communication application programming interfaces (APIs) that empower employees with little coding experience to perform complex communication tasks. It even has an educational video game that helps train these new programmers. Twilio can aid communication through multiple avenues including text, email, video, and programmable voice. Its wide usability has led to its adoption across multiple industries.
Despite how useful the platform is, Twilio has experienced significant stock price volatility due to its high valuation. Twilio has seen its stock price fall more than 5% in a day 13 times so far in 2021. It maintains an expensive price-to-sales multiple of 22 and has only posted one public quarter with positive earnings (Q4 of 2016. Twilio stock took a 17.6% one-day hit in late October for reporting another quarter with a significant EPS loss.
On the bright side, Twilio's third-quarter revenue continued to grow at a rate of 65%, with organic revenue up 38%. Additionally, its net expansion rate stayed above 130%, meaning its existing customer base is spending 30% more than last year's quarter.
Moving forward, management said it's confident it can deliver 30% organic revenue growth over each of the next three years. If this is true, Twilio's revenue for the third quarter of 2024 will more than double to $1.3 billion. Assuming all quarters followed this growth trend, it would also translate to a P/S ratio of 11 on annual revenue of nearly $5 billion. This assumes consistent share count, something Twilio has not done well at maintaining. With its share count increasing about 15% over the past two years, investors should be concerned that their investment is being continually diluted.
If management's 30% growth promise can be kept, current investors should consider holding onto their stock. With Twilio's stock price down nearly 35% from its 52-week high, the market is presenting an opportunity to purchase these shares on sale.
2. EPAM Systems
Many businesses have the vision to come up with game-changing ideas. Few have the resources and expertise to bring the concept to fruition. EPAM Systems helps bring ideas to fruition by assisting with product development, digital platform engineering, and digital product design. It's one of the world's largest manufacturers of custom software and it can handle everything from design, engineering, operations, and optimization for its customers. Its expertise and offerings are diversified across many industries, including financial services, travel, software, business information, and life sciences. Led by its founder, Arkadiy Dobkin, EPAM is a global company that traces its roots to both the United States and Belarus.
EPAM Systems closed out its third quarter with revenue growth of 52%, led by the travel segment (79% growth year over year). This growth was consistent across every region the company serves.
| Region | Third-Quarter Revenue Growth (YOY) |
|---|---|
| North America | 52% |
| Europe | 51% |
| Commonwealth of Independent States | 50% |
| Asian-Pacific | 60% |
Data source: EPAM Systems. YOY = year over year.
EPAM derives 40% of its revenue from outside of North America. The wide reach of EPAM throughout the world and across industries helps it weather any localized economic downturn.
Investors have enjoyed massive gains with EPAM. Shares are up almost 87% in 2021 and it is a 10-bagger over the past five years. Seeing accelerating revenue growth and continued execution through all its segments has investors expecting more of the same.
One metric to watch is the company's valuation. EPAM is a profitable company and has been for some time. Its price-to-earnings (P/E) ratio has increased from around 40 in 2020 to nearly 100 today. This high valuation means EPAM must not slip in its execution, otherwise, the stock will likely get pummeled.
As more and more companies transition into a digital-first world, they will need EPAM's expertise to create solutions. Because of this, EPAM will continue to experience growth and provide long-term stock market outperformance.
Investor takeaway
Both companies are experiencing tailwinds that should continue to blow in their favor. Strong revenue growth is likely to push both EPAM and Twilio stock to outperform the market. Valuation risk looms over both investments, but significant growth can mitigate this concern. As both are high-growth companies, only investors who can stomach significant price volatility should invest in these two. Letting EPAM and Twilio compound uninterrupted within a portfolio is the best option here for current and future shareholders.
