There is a lot to like about The Trade Desk (TTD -3.28%). Thanks to its innovative solutions, the ad-tech company outperformed the broader online advertising market over the last few years, all while generating profits as well. And in addition to some short and medium-term catalysts, The Trade Desk has developed a long-term competitive advantage.
Given its potential, the valuation of this growth stock isn't cheap. Let's see whether shares of The Trade Desk could still be a buy despite getting back to their high mark.
The Trade Desk's business model represents a long-term advantage
According to a study from MAGNA, the digital advertising market in which The Trade Desk operates is expected to grow by 12% in 2020. And despite competing with advertising giants like Facebook and Alphabet, The Trade Desk continues to outperform with revenue of $164.2 million in the third quarter, up 38% year over year. And during the most recent earnings call, management expressed confidence that it will continue to gain market share in 2020.
This solid performance comes from The Trade Desk's business model, which allows advertisers to buy digital media space in a transparent way. Instead of selling blocks of advertising space with limited pricing options, the company developed a more effective and accurate ad-price discovery system that works like a stock market. And in contrast to its largest rivals, which also provide content, The Trade Desk is not exposed to a potential conflict of interest between its customers and the supply side.
That transparency is key as the company leverages its data-driven auctions and reporting. For example, The Trade Desk's measurement tools allow advertisers to use third parties to verify the results they provide. Other advertising channels like traditional TV simply can't compete at the same level due to the data available from legacy broadcast technologies. Besides, the largest online competitors remain reluctant to increase transparency themselves.
And thanks to these differentiated offerings, The Trade Desk is growing an ecosystem of ad inventory that's becoming increasingly challenging to compete with. As the company's customers consume more advertising space, its platform attracts more content providers, which increases the odds of providing advertisers with the ad inventory they demand.
This business model is not without risks, though. A large part of the company's revenue depends on a few major advertising agencies like Omnicom and Publicis. Though concentrated customers reduce sales and marketing efforts compared to dealing with thousands of smaller agencies and brands, the risk of losing a large portion of revenue to just one customer is significant. For instance, in 2018, Omnicom and an affiliate of Publicis represented 10% and 20% of the company's gross billings, respectively.
Recent impressive performance with strong catalysts
The Trade Desk's recent results confirm its strong potential. Bucking the trend of fast growing but unprofitable stocks, the company paired its 38% top-line growth last quarter with a GAAP profit of $19.4 million ($36.1 million on a non-GAAP basis). And management raised its 2019 revenue guidance from $653 million to at least $658 million.
Looking forward, the Olympic Games and U.S. presidential election in 2020 will help boost online advertising opportunities that The Trade Desk can serve with its data-driven solutions. And the secular shift from traditional TV to video streaming should support growth for the online advertising market over the next several years. For instance, the company signed a partnership with Amazon a few months ago to allow The Trade Desk to bid on advertising on Amazon Fire TV devices.
Also, the company will be leveraging its platform in its international expansion. The Trade Desk launched its programmatic ad buying platform in China in March 2019, and during the last earnings call, management described Germany and the U.K. as exciting opportunities. There's plenty of room to grow as U.S. gross billings represented 85% of the total through the first three quarters of 2019.
With such a solid performance in the growing online advertising market, The Trade Desk deserves a premium valuation. But with shares trading at nearly 80 times forward earnings and over 20 times trailing 12-month sales, the margin of safety appears nonexistent. As promising as this company may be, prudent investors should stay on the sidelines for now.