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Shares of Twilio (NYSE: TWLO) have underperformed the broader stock market in 2023, which isn’t surprising as the cloud communications specialist’s growth has stalled on account of weak consumer spending.

Twilio stock is up only 19% in 2023, which is well below the Nasdaq-100 Technology Sector index’s impressive gains of 44%. The company has blamed macroeconomic headwinds for the slowdown in customer spending and the poor financial performance that it has been delivering in recent quarters.

However, Twilio’s results for the third quarter of 2023 seem to have injected some life into the stock. Twilio released its Q3 results on Nov. 8, and the stock was up 5% the following day. Let’s see why.

Earnings are growing rapidly, but that’s half the picture

Twilio’s third-quarter revenue increased 5% year over year to $1.03 billion, which was well ahead of the consensus estimate of $989.5 million. The company delivered a big bottom-line beat as its earnings jumped to $0.58 per share from $0.27 per share in the same period last year. Wall Street would have settled for just $0.36 per share in earnings.

A key reason why Twilio’s earnings increased at such an impressive pace is because of the company’s focus on lowering stock-based compensation. For the fourth quarter, Twilio is anticipating earnings to land at $0.55 per share at the midpoint of its guidance range, which points toward a big jump over the year-ago period’s adjusted earnings of $0.22 per share.

However, this big jump in earnings isn’t going to be driven by growth in Twilio’s business. The company is expecting its top line to increase 1% to 2% from the fourth quarter of 2022 to $1.03 billion to $1.04 billion in the current one. For comparison, Twilio’s revenue increased at a much healthier pace of 22% in the year-ago quarter. It is also worth noting that Twilio clocked faster year-over-year growth in Q3, which means that its business is set to slow down further.

One of the reasons why Twilio’s top-line growth has been anemic is because of its inability to get its existing customers to spend more money on its offerings. This is evident from the company’s dollar-based net expansion rate of 101% last quarter. This metric compares the revenue generated by Twilio’s active customer accounts at the end of a quarter to the revenue generated from the same active customer accounts in the same period last year.

So, a reading of 101% means that its existing customers barely increased their consumption of Twilio’s services, and they didn’t adopt any additional offerings from the company’s portfolio either. Also, Twilio’s active customer accounts increased just 9% year over year to 306,000 last quarter.

All this indicates that the spike in Twilio’s stock price following its earnings report may not be sustainable. Analysts are expecting another year of tepid top-line growth from Twilio in 2024. However, things are expected to improve from 2025, as the following chart will tell us.

TWLO Revenue Estimates for Current Fiscal Year data by YCharts.

What should investors do?

Though Twilio’s growth has stalled of late, it is not surprising to see why analysts are anticipating its revenue to start increasing at a faster pace from 2025. After all, the company is a key player in the cloud communications market that’s expected to clock an annual growth rate of 18% through 2028, generating $34 billion in annual revenue at the end of the forecast period.

The cloud communications market is expected to generate $14.5 billion in revenue this year. Given that Twilio is on track to finish 2023 with a top line of almost $4.1 billion, it currently controls 28% of this fast-growing market. So, the company’s revenue growth could return once customers start opening their wallets.

The good part is that Twilio management is witnessing signs of stability in the end market, as CFO Aidan Viggiano said on the latest earnings conference call. Also, Twilio has been integrating AI into its offerings, and this strategy could play a key role in accelerating the company’s growth by opening up new revenue opportunities.

So, investors who can wait patiently for Twilio’s growth to hit a higher gear may want to start accumulating the stock while it is still subdued, especially considering that it is trading at 2.5 times sales. That’s way lower than its five-year average sales multiple of 15. Also, the company’s focus on improving its profitability explains why its earnings are expected to grow at an annual pace of 102% for the next five years.

As such, Twilio may turn out to be a good investment in the long run as the stock could regain its mojo, but it will still have to overcome the near-term slowdown that it currently faces.

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

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