While using Wall Street analysts' projections to blindly buy and sell point for stocks probably isn't the greatest strategy, it's never a bad idea to double-check with a few of them to ensure you're not missing any vital information before making an investment decision. These analysts may have different goals and timelines than you, so their words shouldn't be the final say in an investment decision.
Still, analysts can also help investors identify stocks that are undervalued which, after further research, could lead to a great investment idea. One stock that many analysts now think is primed to skyrocket is Twilio (TWLO 1.47%). Right now, among the 27 analysts covering the stock, the average 12-month price target for Twilio sits at $136.85. That's 90% higher than where it trades today, which would be a pretty solid return. So should investors trust those projections and purchase Twilio shares?
Customer communication is Twilio's business
If you live in the U.S., it's nearly impossible for you to have avoided getting a two-factor authentication code or doctor's appointment reminder sent to your phone via text. You've also likely seen personalized marketing emails tailored to your preferences. These actions are all in pursuit of a better customer experience and are likely powered by Twilio's APIs (application program interfaces).
The coding behind automating text messages or emails is rather tricky. Fortunately for the end user, Twilio's APIs allow for easy plug-and-play, so anyone (aka, non-software engineers) can set up these seemingly complicated programs.
Twilio is all in on being the go-to company in all things communication. It doesn't just facilitate emails or texts. Its clients can program voice messages, set up video calls, create a cloud contact center, and gather customer data to market more efficiently. It also charges clients no subscription fees. Instead, its customers pay each time a text message is sent, a call is routed, or a personalized email is created. This model aligns Twilio's interests with those of its customers, ensuring a business isn't being overcharged just because they don't use a platform to its full potential.
Twilio's product pitch to investors and customers is pretty straightforward, but how is the business doing?
Strong results in a challenging environment
Despite weakness across the enterprise software space, Twilio's second quarter was strong. It reported organic revenue growth of 33% (excluding acquisitions made in the past year) and overall revenue growth of 41% to $943 million. It also achieved a non-GAAP gross margin of 54.3%, up from 51% in the prior-year period, reflecting its increased efficiency.
However, investors must keep this gross margin in mind when valuing the stock. Because Twilio has to pay to use text messaging or video infrastructure, its gross margins are much lower than those of typical software-as-a-service (SaaS) companies. Therefore, Twilio's profit margins won't be as large when its business fully matures as some of its peers. The market has factored that reality into its stock valuation, which is one reason Twilio looks cheap when examined in a vacuum.
TWLO PS Ratio data by YCharts
Many investors wouldn't believe you if you told them you knew of a fast-growing tech stock valued at under 4 times sales, but that's the reality with Twilio. However, the valuation makes more sense when the gross margin is accounted for.
But is this seemingly cheap price still too expensive?
I don't think so.
At the end of the day, investors don't care about sales -- they want profits. And Twilio has never produced a profit since it became a public company. Admittedly, that's by design. Management wants to create the best customer communication platform on the market, and it has spent heavily on doing so.
Co-founder and CEO Jeff Lawson has stated that one of Twilio's goals is to start achieving annual non-GAAP operating profitability in 2023. However, that statement is hedged: Twilio could remain unprofitable on a GAAP (generally accepted account principles) basis, and operating profits don't necessarily translate into earnings per share.
Still, that forecast suggests that the investment thesis for Twilio is on track. As a bonus, Lawson also projected 30% annualized organic revenue growth through 2024.
Based on that bright outlook, Twilio's stock appears fairly valued, if not undervalued. This sentiment is also reflected in analysts' projections.
With Twilio's stock down more than 80% from its high, I think investors can take a position in Twilio if they are committed to holding the stock for the long run, as profits are just around the corner.
