Is The Trade Desk Stock a Buy?

Shares of The Trade Desk (TTD -0.54%) are up nearly 80% in 2020 as of this writing, capping off an epic climb of over 1,400% since the company went public in 2016. That's not to say the COVID-19 pandemic and ensuing recession have been kind to the cloud computing-based advertising platform. Nevertheless, after a brief slump, the company is back in growth mode, and it has plenty of potential left in the decade ahead -- even if shares are priced at a sky-high premium.

A setback for digital advertising

The pandemic gave the global advertising industry a black eye. According to researcher eMarketer, global ad spend will fall 5% in 2020. Even digital ads are hurting, with an expected increase of just 2% from 2019. Growth is growth, but eMarketer says that the digital ad industry has never slowed to a single-digit percentage pace before. 

Image source: Getty Images.

However, there are significant takeaways here. With digital still (barely) on the rise, but the more-than-$600 billion in annual spend overall expected to fall, traditional ads will once again lose ground. And if eMarketer's forecast proves correct, digital will make up some 54% of the grand total spent on various forms of commercials and promotions and is well on its way to reaching half-a-trillion dollars in annual spending within the next few years. 

For The Trade Desk, while 2020 will go down as a forgettable year in the early stages of its existence, this shift means it's still playing in an expanding sandbox. And in the wake of the pandemic, the programmatic ads it specializes in -- automating marketing spend and targeting audiences using data -- could be more attractive to marketers than ever as they look to pare down expenses. In fact, after reporting a 13% revenue decline during the second quarter of 2020, CEO Jeff Green and the executive team said year-over-year growth had already returned by the end of June. Q3 revenue is expected to increase at least 8% to $177 million, and generate $30 million in adjusted EBITDA (earnings before interest, tax, depreciation, and amortization). Not bad for a company still prioritizing growth, and in the midst of a downturn.

In fact, The Trade Desk's growth, paired with ample profitability -- even in tough times -- is a compelling reason to give this ad tech stock serious consideration. And as the company grows, it's achieving greater scale and growing its bottom line at an even faster rate.

EBITDA = earnings before interest, tax, depreciation, and amortization. Free cash flow = revenue minus cash operating and capital expenses. Data source: The Trade Desk. 

Ample cash, low debt, and an industry ripe for consolidation

There's also a clean balance sheet to consider. As of the end of June, The Trade Desk had $555 million in cash and short-term investments and only $142 million in debt. This small technologist doesn't have the tens of billions the Alphabet, Facebook, and Amazon digital ad triopoly has, but it's an ample war chest that keeps getting filled thanks to the company's profitable operations. 

The net cash position should help the cloud platform continue its pace of expansion. Though dominated by the aforementioned tech giants, the remaining digital ad industry is fragmented across many smaller players and could be ripe for consolidation in the years ahead. Expansion outside of the U.S. (88% of sales were in North America in Q2 2020) and TV ads (connected TV grew 40% in Q2) are particularly promising. 

But what about the price tag? Based on trailing 12-month metrics, The Trade Desk shares are going for over 32 times revenue and 212 times free cash flow. Both metrics should improve as the company returns to growth, but it's nevertheless a steep premium -- and at this point, The Trade Desk doesn't top my list of stocks to buy right now as it did earlier in the year. 

However, for those investors who don't own it yet and are willing to sit tight for at least a few years, I still believe The Trade Desk is worth owning. If the premium isn't to your liking, start with a very small position (perhaps less than 1% of your total portfolio value) and plan on making more small purchases over time (monthly, quarterly, or after the stock has one of its not-unheard-of 20%-or-more pullbacks). As the digital ad industry continues to take over traditional marketing, there is plenty of room for this technologist to keep growing.