Former underdog DoorDash (DASH 3.33%) may have achieved top-dog status in record time. According to the company, it only had 17% of the delivery market in Jan. 2018. By Oct. 2020, its market share had risen to 50%. This rapid ascent is a big reason why investors love this stock so much. 

Demand for DoorDash stock has been epic. The company originally planned to price its initial public offering (IPO) between $75 and $85 per share, but the IPO eventually priced at $102 before its first day of trading carried it to almost $190. As of this writing, shares trade at around $200 per share.

Through the first three quarters of 2020, DoorDash registered a net loss of $149 million. But investors appear indifferent toward these steep losses since they're willing to envision this company as the premier delivery-logistics network with broad application globally. There's merit to this thesis, but there's also good reason to temper this rosy outlook with realistic expectations.

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Image source: Getty Images.

The case for DoorDash

Through the first three quarters of 2020, revenue increased more than 200% year over year to $1.92 billion. Unimpressed critics say COVID-19 drove industrywide growth, which is true. But DoorDash also grew revenue by nearly tripling its market share in under two years. Peers include first-mover Grubhub and the more diversified Uber. Give DoorDash credit for winning business from powerful players like these.

It is winning thanks to its counterintuitive decision to focus on smaller markets. Now, with over half of the overall market, it's in an enviable position. DoorDash's wider availability increases its consumer appeal, which in turn attracts more third-party delivery drivers ("Dashers") to the platform. After all, greater order volume means less downtime and higher earnings potential for them.

With its improving scale and a horde of Dashers standing by, DoorDash has greater leverage for its platform. The company sees itself as a comprehensive delivery logistics network -- something like that could disrupt grocery, pharmacy, and last-mile delivery in the U.S. and beyond. 

This vision won't be realized overnight, but I applaud long-term thinking from the company and its investors. If there's going to be a global logistics network, DoorDash is positioned as well as any other player in the space.

Tempering expectations

I absolutely love platform companies (Etsy and Airbnb are great examples), because they don't actually have a physical product. They're simply platforms connecting two independent parties (although some provide ancillary services). As such, profit margins are extremely high. They also benefit from a network effect. For example, more shoppers at Etsy will attract more sellers, and vice versa. Moreover, because these platforms are digital, they scale extremely well -- you build it once and sell it over and over.

DoorDash is a platform company, but it also lacks some of the key benefits. That's because there's a crucial third element to its equation. Most platform companies simply worry about the buyer and seller, but DoorDash has Dashers operating in the middle, making the overall economics of this business extremely complicated.

Management has conceded (indirectly) that Dashers are a problem. When companies file with the Securities and Exchange Commission, they're required to list perceived risks. When DoorDash registered to go public, it said developing autonomous delivery vehicles or drones could materially improve its cost structure. The risk is failing to do so. 

In other words, DoorDash recognizes its business model needs improvement, and replacing Dashers with drones or self-driving cars is one answer. However, one of its competitive advantages is precisely its network of third-party drivers. If technology replaces Dashers, the moat could erode as companies with more experience in these technologies jump in. Both Amazon and Uber are listed as competitors in this scenario.

A man delivers food to a woman.

Image source: Getty Images.

Is it a buy?

DoorDash could make cost-structure improvements in other ways. For example, its subscription service DashPass can make its platform more sticky, reducing sales and marketing expenses. Or the company could start generating revenue from higher-margin ancillary services like in-app advertising to improve its bottom line. 

There are profitable possibilities, but investors are paying up now for unproven opportunities. The stock currently trades for a price-to-sales ratio of 29. By contrast, Grubhub is much cheaper, trading at less than four times revenue. These are the things keeping me on the sideline with DoorDash stock.

Long term, the economics of this business have to improve. Perhaps the stock can keep going up in the near to mid term as the company keeps taking market share. But looking out further, profits are needed to create lasting shareholder value. 

Investors will get a better picture of DoorDash's future when it reports quarterly earnings on Feb. 25 after the market closes.