The Trade Desk Is an "Expensive" Stock, but For Good Reason

Shares of advertising automation platform The Trade Desk (TTD 4.15%) soared more than 250% higher in 2020, and the fourth-quarter report card released on Thursday afternoon gave more impetus to the triple-digit percentage rise.

The company's revenue growth accelerated in the final months of the year as marketing continues to make a massive shift toward a digital format. Connected TV (or CTV, streaming, and other internet-based video services) is also a massive tailwind for The Trade Desk, one that should continue lifting the company higher for the foreseeable future.

This is an incredibly expensive tech stock, but for incredibly good reasons.

2020 by the numbers

The Trade Desk founder and CEO Jeff Green said on the earnings call that ad spending on the company's platform hit a new record (an unlikely outcome a year ago when the pandemic started) of $4.2 billion -- a 34% increase over 2019. Q4 spending alone was $1.6 billion, and CTV spending doubled as marketers took advantage of the extra time consumers spent at home watching television. For reference, Green cited an eMarketer estimate that global ad industry spending fell 4.5% in 2020.  

Image source: Getty Images.

It equated to Q4 revenue of $320 million, a 48% increase from a year ago and an acceleration from the 32% pace reported in the third quarter. Adjusted EBITDA was $153 million. Yup, that's right, an adjusted EBITDA profit margin of 48%. This is an incredibly profitable cloud software company. Paired with results from the rest of 2020, The Trade Desk made some pretty good lemonade out of the lemons it was handed last year.  

Data source: The Trade Desk.  

The Trade Desk also finished the year with $624 million in cash and equivalents and zero debt. It's an incredible position of strength to be in, especially as TV -- the largest segment of global ad spend -- is being disrupted and becoming more flexible. As Green put it, "Video is the best channel to win the hearts and minds of consumers." And The Trade Desk's platform enables just the sort of adaptability needed in this new digital era.

Valuation matters, except when it doesn't

I'm clearly biased in thinking The Trade Desk is a great company, but what of valuation? Is paying over 50 times trailing 12-month revenue (the stock's current price-to-sales metric based on a market cap of $42.4 billion) really a good idea? If you're looking at where this digital ad platform will be in a year's time, probably not.  

But over the course of the next decade, I can't conjure up a better place to be invested in the world of digital ads (except maybe Magnite (MGNI 1.73%), a peer to The Trade Desk that works with content producers looking to sell ad slots). It goes beyond the company's expected revenue growth in the immediate future -- which, by the way, was forecast to be at least 33% higher in first-quarter 2021 (to $214 million to $217 million) and equate to adjusted EBITDA of $55 million.  

Green often references "the rule of 40" during the quarterly earnings calls (which, if you haven't started doing so, are really worth listening to every few months). Investors in young fast-growing technology companies will use the rule of 40 to judge the health of a business, which is calculated by adding the profit margin to the revenue growth rate. Anything over 40% is considered a healthy business. As Green pointed out, The Trade Desk finished 2020 at 60% (26% growth plus profit margin of 34%, when using adjusted EBITDA margin). For Q1 2021, expected revenue growth plus adjusted EBITDA margin is 59%. And that includes the heavy pace at which the company is spending to foster further expansion.  

Of course, this is a subjective valuation metric that simply shows an investor the quality of the growth a company is managing. I'm certainly not going to encourage anyone to load up on a stock trading for over 50 times 2020 revenue (although I personally plan to buy more). Nevertheless, The Trade Desk has momentum on its side and plenty of cash, and it could choose to use its hefty stock price as a type of currency to raise more cash or make a splashy acquisition (by issuing more shares).

Put another way, I wouldn't bet against The Trade Desk. At the very least, this cloud software stock should remain on your watch list.