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My Top Growth Stock for the Second Half of 2019

Harsh Chauhan, The Motley Fool

It looked like cloud communications specialist Twilio (NYSE: TWLO) could set the stock market on fire once again in 2019 after last year's terrific run, which is why, back in February, I called it my top growth stock for the year. It is safe to say that Twilio stock hasn't disappointed so far, gaining more than 50% in the first half of the year.

The good news is that Twilio stock isn't done growing, and that's why it remains my top growth pick for the second half of the year. Let's take a look at what makes this cloud play a stock worth holding onto.

Men in suits hanging onto an arrow pointing upward.

Image Source: Getty Images.

Growth keeps getting better

The best thing about Twilio is that its revenue growth has accelerated for five quarters in a row thanks to a burgeoning customer base and higher spending on its offerings.

Chart showing Twilio's active customer accounts and base revenue growth.

Data source: Twilio's quarterly reports.

The number of active customer accounts has been increasing at a terrific pace, quarter after quarter. The metric saw a massive spike in the first quarter of 2019 thanks to Twilio's acquisition of SendGrid. The company exited the quarter with more than 154,000 active customers as compared to just under 54,000 in the prior-year period.

The SendGrid acquisition brought 84,000 customers into Twilio's fold, paving the way for higher revenue growth in subsequent quarters. However, Twilio was already witnessing a sharp expansion in its base revenue growth rate even before SendGrid came into the picture, as evident from the chart above.

Twilio's base revenue excludes revenue from those customers who have not entered into a minimum 12-month revenue commitment. Base revenue accounts for 94% of the company's total revenue, so the increase in this figure bodes well for Twilio, because it indicates that more of its customers are entering into long-term contracts.

On the other hand, the company's dollar-based net expansion rate has also stepped on the gas in recent quarters. This metric measures the amount of money individual customers are spending on its products. An increase in the dollar-based net expansion rate indicates that Twilio customers have increased their usage of the company's products, as a result of which they are spending more money.

Last quarter, the company's dollar-based net expansion rate came in at 146% as compared to 132% in the year-ago quarter. And don't be surprised to see this metric accelerate further, since the SendGrid acquisition will allow Twilio access to more customers and gives it more products to sell.

This is one of the reasons the company expects its annual revenue to hit $1.1 billion in 2019, up 69% from the prior-year period. For comparison, Twilio's annual revenue had jumped 63% in 2018 as compared to 2017 levels, which makes it clear that the company's growth is set to go a notch higher.

Expensive but worth it

One thing that investors won't like about Twilio stock is its valuation. The stock trades at a whopping 464 times forward earnings estimates.

Twilio needs to keep growing at a rapid pace to justify that sky-high valuation, and this is what's expected of the company. Analysts estimates compiled by Yahoo! Finance show expectations are for Twilio's adjusted earnings to more than double in 2020 to $0.30 per share. That would represent a massive jump over the $0.12-per-share earnings estimate for 2019, which is just a penny higher than last year's earnings figure.

This means that Wall Street expects Twilio to start delivering bottom-line growth sooner than later. But will that be possible given the company's aggressive spending?

TWLO Total Operating Expenses (% of Quarterly Revenues) Chart

TWLO Total Operating Expenses (% of Quarterly Revenues) data by YCharts.

Expecting Twilio to boost its profitability seems like a pipe dream right now; the company has been raising its operating expenses in order to power up revenue growth. The company's GAAP losses increased last quarter to $0.31 per share as compared to $0.25 per share in the year-ago period.

However, its adjusted earnings came in at $0.05 per share as compared to a loss of $0.04 in the year-ago period. Twilio believes that it can deliver between $0.11 and $0.13 per share in earnings this year thanks to accelerated revenue growth.

More importantly, Twilio seems capable of hitting analysts' earnings target next year as the email market industry in which SendGrid plies its trade is expected to be worth $22 billion in 2025 as compared to $4.51 billion a couple of years ago, according to Transparency Market Research.

Technographics provider Datanyze estimates that SendGrid holds 13% of the email marketing industry. Assuming that the market grows as large as Transparency anticipates and SendGrid manages to hold on to its market share, Twilio's top and bottom lines could increase substantially. That should justify its valuation and potentially lead to more stock upside.

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Harsh Chauhan has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Twilio. The Motley Fool has a disclosure policy.