With just a week left in 2020, shares of The Trade Desk (TTD -4.34%) are up an astounding 255% -- making this one of my best-performing holdings on the year.
The Trade Desk went from a relatively small company to one currently valued at a market cap of $43 billion. That makes this one of the largest digital advertising technologists around -- not to mention an incredibly expensive stock (it trades for 61 times trailing-12-month sales!).
But given the massive size of the industry overall and upcoming changes to consumer privacy, there could be years' worth of gains left in the tank. Don't remove this software-as-a-service stock from your 2021 watch list just yet.
A big year for digital ads
Global spending on marketing took a hit in 2020 -- as is typical during recessions. As a result, The Trade Desk's platform for buy-side ad spend (for marketers, versus a sell-side platform like Magnite (MGNI -2.08%) that helps producers monetize their content) stumbled early in the year as many organizations pumped the brakes on their promotional efforts.
Image source: Getty Images.
However, after a 13% year-over-year decrease in revenue in the second quarter, The Trade Desk came roaring back with a 32% year-over-year increase in revenue in the third quarter. At the midpoint of guidance, management expects another 34% year-over-year increase during the final quarter of 2020. Not bad for a company navigating effects from a global pandemic and economic upheaval.
The Trade Desk's quick return to growth only partly explains the huge run-up in share price this year, though. Based on the aforementioned guidance, The Trade Desk expects to haul in total revenue of just over $800 million in 2020. That's a big business to be growing at a rate north of 30%. However, in the grand scheme of things, it's small potatoes. According to research firm eMarketer, global ad spending will be over $600 billion this year and could be close to $700 billion in 2021. Of the total, digital ads represent just over half, but continue to overtake traditional advertising.
Besides a general increase in all things digital, The Trade Desk is specifically benefiting from growth in internet-based TV around the globe. Given that television remains the largest category for ad spend, suffice to say this company still has massive potential ahead of it as media companies and their advertising partners make the switch away from traditional entertainment to streaming. In fact, The Trade Desk reported its sales from connected TV more than doubled in the third quarter. Digitization of other entertainment is providing a boost as well, with mobile video and digital audio (internet radio, podcasts, etc.) both up about 70% year over year in Q3.
Plenty of cash to capitalize on an industry shake-up
Put another way, The Trade Desk's stock trades for such a hefty premium for a reason. In the next decade, global advertising is expected to be worth $1 trillion a year with the majority of it spent in a digital format. And this company's platform to automate the purchasing and performance tracking of ads is clearly winning with customers -- as is made evident by the enduring growth story even in tough times.
Within the digital world, industry changes could also favor The Trade Desk's fortunes. Apple announced it was taking steps to end application activity tracking on its devices in support of better user privacy. But The Trade Desk has already adapted to those privacy changes and is helping its partners craft targeted ads without specific user data. If app and web tracking does go away (or gets harder to do), there's an opportunity here for The Trade Desk to make further inroads in the industry and scoop up more market share.
As it adapts to digital ad policy changes and looks for new ways to expand its reach in the broader marketing universe, the company's highly profitable operation and large net cash balance will help its cause. Though growth is the main priority, the company generated free cash flow (revenue minus cash operating expenses and capital expenditures) of nearly $176 million through the first nine months of 2020 -- good for a free cash flow margin of 34%. Add to that cash and short-term equivalents of $557 million (offset with debt of only $72 million), and this technologist has ample liquidity to draw on to maximize its expansion.
But what about the steep premium? The Trade Desk is undeniably pricey after an epic 2020. Investors have bid up the expectation that revenue will continue to increase well into the double-digit percentages for many years. However, if that's your expectation, too (as it is mine), and you plan to stay invested for the next five years or more, the price tag should be less of a concern. Just remember to stay properly diversified; there's no reason to bet the farm on one company.
But don't bet against this cloud computing stock's long-term potential, either. Even after a tremendous run, this is still a small part of a massive and fast-growing industry. I for one am still a happy shareholder.
