During earnings season, investors (and the general public) are given a snapshot of where a public company stands financially. While the numbers reported are important, it's often what management says during a conference call or in its earnings release that actually drives market sentiment regarding how the stock should be priced. By their nature, the numbers tend to be retrospective, while the comments often give some outlook on the future of the company.
Twilio's (TWLO 1.47%) management had multiple items to discuss in its prepared remarks following the fourth-quarter earnings release last week, but investors should really take notice of two items that stood out above the rest in terms of the potential for Twilio's stock.
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1. Twilio is seeing sustained organic revenue growth
Twilio's software provides its customers with APIs (application program interfaces) that help users with little coding experience to write complicated programs they need for their businesses. More specifically, Twilio focuses on communication solutions for text messaging, email, voice, and video. By empowering both large and small businesses alike to communicate with clients, Twilio has ushered in a new customer service standard.
Businesses are clearly using text messages more in daily routines, whether it is for multi-factor authentication or an appointment reminder. Twilio powers both of these types of services (as well as many others), and business has been good. Since 2017's Q1, Twilio has grown its quarterly revenue at least 41% year over year every quarter. Starting in Q1 of 2019, Twilio began making numerous acquisitions in its quest to become the go-to place for all communication tasks. As a result, its general revenue metric really doesn't provide a full picture of how this company is growing.
For example, say Twilio made $1 billion in quarterly revenue, and then the next year it grew sales at 10% to $1.1 billion but it also bought a company that had $500 million in sales. The standard revenue-growth statistic would say revenue grew a strong 60% -- as it accounts for the acquisition's revenue -- while the organic revenue growth is a mere 10%. Organic revenue measures how the core business is doing, not its acquisitions. Twilio recognizes this and provides investors its organic revenue metric in tandem with its total revenue.
Twilio's organic growth is still impressive by most standards. Q4's organic revenue grew 34% year over year to $685 million versus total revenue, which increased at a 54% clip to $843 million. Growing at a sustained 30% rate is not common for companies, but Twilio's management is bullish on the idea it can continue this pace.
While commenting on Q4, CEO and co-founder Jeff Lawson said Twilio can deliver at least 30% organic revenue growth through 2024. If Twilio can pull it off, investors should be thrilled by the return potential. With 2021 full-year organic revenue of $2.4 billion, 30% growth will more than double the value to $5.3 billion by 2024. Without adding in any of its acquisition revenue and valuing it at a 10 times price-to-sales (PS) ratio (its current valuation), Twilio could have a market cap of $53 billion in 2024 -- representing a 56% stock price gain in three years, or 16% annually.
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2. Twilio is getting closer to profitability
While this sustained revenue growth presents a solid argument for the stock, the bears have long attacked Twilio for never turning a profit on all this revenue growth.
Lawson addressed this concern as well in his comments, saying that Twilio expects to produce non-GAAP (generally accepted accounting principles) operating profitability on an annual basis starting in 2023. This would mark Twilio's shift from a growth-at-all-costs mindset and start its transition to a mature business -- something Wall Street likes to see. Management is targeting a 20% non-GAAP operating margin when it reaches full profitability, but that threshold may still be years away.
If Twilio can throw off the unprofitable stigma from the business, it should help the stock experience less volatility. Twilio's stock happens to be trading at the bottom of a volatility swing right now, and the price is down more than 55% from its all-time high. When looking at valuation, Twilio has returned to its pre-pandemic price-to-sales ratio levels.
TWLO PS Ratio data by YCharts.
Recently, investing headlines have been filled with warnings about high-flying unprofitable tech stock valuations being slashed because the markets' appetite for growth decreases as the federal funds rate increases. While this is true, Twilio stock is already trading below the valuation reached during the last rate-hike cycle in December 2018. Big banks like Bank of America are calling for as many as seven interest rate hikes during 2022, which would set the funds rate between 1.75% and 2%. Twilio traded around a 15 P/S ratio during the period when the funds rate was last around that level.
Another factor is Twilio's low gross margins, as Twilio must operate software and pay for messaging fees charged by carriers. While many SaaS (software-as-a-service) companies have gross margins ranging between 70% and 80%, Twilio's are much lower at a 51% GAAP gross margin. Because of this, investors must be wary when comparing Twilio's valuation to other companies -- as it is unique among its SaaS brethren.
Investor takeaway
Investors can likely buy into Twilio's stock now with little fear of it being sold off much further. Business is strong and it has tailwinds pushing further growth. It won't be long before the stock follows suit. Management is bullish on Twilio's prospects, and investors should feel encouraged by its potential as well.
