Hedge funds have built large positions in the stock.
The average analyst has remained bullish on the stock for over a year now.
Twilio is priced for perfection at nearly 12x '20 revenue estimates.
The importance of paying the right price has hardly ever been more important than in the current stock market. The recent market has consistently overpaid for growth and gotten burned.
In the case of Twilio (TWLO), the market had no business paying over $90 for the stock last November, and those buying on the surge to over $150 have already taken a beating. A couple of recent bull calls have the stock on the verge of another rally, but investors should unload the stock back above $125, as massive revenue growth deceleration will kill Twilio in 2020.
Never This Bullish
Both analysts and hedge funds are very bullish on Twilio. According to data from Insider Monkey, hedge funds have never had this many positions in the stock. The total hedge funds owning Twilio has jumped three-fold since mid-2017, when less than 20 hedge funds owned the stock.
At the same time, the number of analysts bullish on the stock are near the all-time high. Currently, 13 analysts have a Buy rating and 7 analysts have an Outperform rating. Back in March and April, the peak was 21 analysts with a bullish rating.
Considering Twilio has added coverage from several analysts in the last few months, the best rating measure is likely the average analyst rating now at 4.43. The rating peaked last October at 4.68 and hasn't changed that much in the year despite the massive stock gains through July.
No better example exists of analysts being far too bullish on the stock than RBC starting Twilio with a $135 price target. The stock has a market value of $17.4 billion based on the 150 million shares guided for Q3, yet the analyst sees nearly 20% upside (pushing market cap to $20.5 billion) for Twilio, while only projecting quarterly revenues of $287.9 million in revenues.
The magnitude of these numbers doesn't match. This usually happens after a period of accelerating revenue growth boosted by acquisitions. The same issue happened with Square (SQ) in 2018, when the current $60 stock surged to $100.
Twilio has followed this pattern, with the SendGrid deal boosting the reported 2019 revenue growth. The stock followed suit in 2019, soaring to nearly $150, while growth peaked at 86% in the last quarter.
Revenue growth will slip into the 30% range the next couple of years, and investors aren't going to find the stock nearly as appealing with the decelerated revenue growth. Clearly, CPaaS products are disrupting the enterprise market, and the company is in an attractive position. The key is that paying the right price for the stock matters.
Twilio already trades above 11.7x '20 revenue estimates of $1.48 billion. The P/S chart used by most investors doesn't have the correct share count and uses a market cap of only $15.5 billion. Either way, the stock valuation is maxed out, yet analysts want investors to pay more into decelerating revenue growth.
Other similar stocks that traded at massive P/S ratios like Zscaler (ZS) and Square (SQ) have seen massive stock declines. Square has a cheaper P/S now than Twilio, showing the potential for more stock weakness in Twilio.
A similar stock such as CrowdStrike Holdings (OTC:CRWD) is down over 45% from the highs, and Citi just came out with a Sell rating on the stock. The whole problem with paying the large multiples due to momentum is that suddenly the stock is down 50% and the investor base still doesn't see value, because no basis existed for the stretched valuation in the first place.
The key investor takeaway is that Twilio is priced for perfection, as most hedge funds and analysts are already bullish on the stock. Investors should use the next rally to exit any position and wait for a period of weakness before owning the cloud communications leader long term.