The Trade Desk (TTD -0.23%) has pulled back nearly 53% from its all-time high. This sell-off in the stock, however, creates a great long-term opportunity for investors who are optimistic about the digital advertising space.
The Trade Desk continues to make progress expanding into its addressable market. There are concerns about the business, but I think it's a risk worth taking for the long term.
Another blockbuster quarter
The Trade Desk operates on the buy side of the advertising technology (adtech) space, which means it focuses on helping advertisers find places to show their ads online. This is opposed to the sell side where companies like PubMatic help publishers find the best offer for their available ad inventory. The Trade Desk and sell-side providers are not competitors but rather partners connecting buyers and sellers.
Facilitating this connection is crucial for advertisers: Without companies like The Trade Desk, advertisers would have to hunt down publishers on their own, which would be time-consuming and less effective. The Trade Desk makes sure ads are placed in front of the right target audience, and customers like what the company has to offer as it has reported churn below 5% for the past eight years.
It's one of the top dogs on the buy side with over 225 supply partners. This includes two of the biggest sell-side platforms, PubMatic and Magnite, along with large companies like Spotify. The extensive amount of ad inventory being offered on the platform led to $315 million in first-quarter revenue, an increase of 43% year over year.
It is also turning that top-line expansion into cash efficiently. In the first quarter, the company's free cash flow reached $136 million, meaning that roughly $0.43 of every dollar in revenue turned into free cash flow.
This leadership position is paying off, but there are both smaller pure plays and larger competitors like Alphabet and Adobe that compete in the industry as well. The Trade Desk's vast number of partnerships is its advantage over smaller competitors, and its neutrality sets it apart from the larger ones.
Alphabet, for example, has an incentive to push advertisers to promote their business on Google, whether or not it is truly the best place for advertisers to go. The Trade Desk, however, does not have those incentives, making it a neutral third party focused on finding the best ad space for its customers.
The future of digital advertising
There is still plenty of room for The Trade Desk to capture market share in the adtech industry. In 2021, the company had roughly $6.2 billion in digital ad spending run through its platform, but that is peanuts compared to the $439 billion spent globally on digital ads in 2021.
One especially exciting growth prospect is connected TV (CTV) advertising. Ad-supported streaming services are becoming increasingly common, and this has resulted in CTV being The Trade Desk's fastest-growing advertising channel. CEO Jeff Green predicts that every major streaming service -- including Netflix -- will have an ad-supported version of its platform by the second half of 2023. If this happens, The Trade Desk could see tons of increased activity from advertisers placing ads on streaming channels.
What could go wrong?
But there's no guarantee that ad-supported streaming will become the large market that Jeff Green expects. While streaming companies seem to be focused on ad-supported offerings, consumers could eventually prefer to just pay up for ad-free streaming.
Another risk to The Trade Desk is a recession: 88% of The Trade Desk's ad spend was in North America in the first quarter of 2022, and there are concerns about the U.S. falling into a recession in the near future. If it were to hit the U.S., that could reduce ad spending overall.
The company trades at 17 times sales and 55 times free cash flow, so shares are by no means cheap. PubMatic -- another adtech stock -- trades at just five times sales and 21 times free cash flow.
Despite these risks, The Trade Desk is still worth buying. The company is one of the leading platforms on the buy side today, and it has generated significant revenue and free cash flow to show for it.
The company is also riding the tailwinds of some appealing growth opportunities. Because of its high valuation, investors might want to dollar-cost average into a position. If it can maintain its leadership with the most ad inventory available for advertisers, The Trade Desk is well positioned to capitalize on the massive opportunity ahead of it.