It's been a strong day for Twilio. Its shares are trading at $77.42, marking a 9.2% change since the previous market close after it announced it was slashing 11% of its workforce. An analyst favorite, the Internet Content & Information company has a rating of buy. But could the market and the anayst community be overvaluing this stock?
The first step in determining whether a stock is overvalued is to check its price to book (P/B) ratio. Thus is perhaps the most basic measure of a company's valuation, which is its market value divided by its book value. Book value refers to the sum of all of the company's tangible assets minus its liabilities -- you can also think of it as the company's liquidation value.
Traditionally, value investors would look for companies with a ratio of less than 1 (meaning that the market value was smaller than the company's book value), but such opportunities are very rare these days. So we tend to look for company's whose valuations are less than their sector and market average. The P/B ratio for Twilio is 1.3, compared to its sector average of 2.73 and the S&P 500's average P/B of 2.95.
Modernly, the most common metric for valuing a company is its Price to Earnings (P/E) ratio. It's simply today's stock price of 77.42 divided by either its trailing or forward earnings, which for Twilio are $-5.43 and $0.16 respectively. Based on these values, the company's trailing P/E ratio is -14.2 and its forward P/E ratio is 483.9. By way of comparison, the average P/E ratio of the Communication Services sector is 18.37 and the average P/E ratio of the S&P 500 is 15.97.
The problem with P/E ratios is that they don't take into account the growth of earnings. This means that a company with a higher than average P/E ratio may still be undervalued if it has extremely high projected earnings growth. Conversely, a company with a low P/E ratio may not present a good value proposition if its projected earnings are stagnant.
When we divide Twilio's trailing P/E ratio by its projected 5 year earnings growth rate, we obtain its Price to Earnings Growth (PEG) ratio of 44.96. A balanced PEG ratio should be around 1, and companies that are undervalued in terms of growth will have ratios lower than 1. It's clear that in Twilio's case, its value is very inflated compared to growth expectations.
Indebted or mismanaged companies can't sustain shareholder value for long, even if they have strong earnings. For this reason, considering Twilio 's ability to meet its debt obligations is also an important aspect of pinning down its valuation. By adding up its current assets, then subtracting its inventory and prepaid expenses, and then dividing the whole by its current liabilities, we obtain the company's Quick Ratio of 6.116. Since TWLO's quick ratio is higher than 1, its total liquid assets are sufficient to meets its current liabilities.
When we had up all the inflows and outflows of cash, including payments to creditors, we obtain Twilio 's levered free cash flow of $270,077,120. This represents the money left over from the company's operations that is available for reinvestment in the business, or for paying out to equity investors in the form of a dividend. Despite its positive cash flows, Twilio does not currently pay a dividend.
Overall, shares of Twilio appear to be overvalued at today's prices. If analysts are recommending the stock, it is likely due to qualitative factors, as opposed to the quantitative factors we reviewed above. Just be sure to do your own due diligence if you are interested in taking a long position in TWLO. To stay abreast of the latest market news, make sure to subscribe to our free daily newsletter!
