Tech stocks are rockin' and rollin' again. After getting decimated by the bear market in 2022, a number of high-quality names have been thrown out with the trash. But some investors are waking up to the deals and going shopping.
Take The Trade Desk (TTD 0.70%), for example. The digital-advertising software company is up over 30% through the first quarter of 2023, and more than 50% from its lows last summer (a low point that was briefly re-tested in November 2022). This best-in-breed software company has always had a premium price tag, and it's certainly more expensive now than it was just a few months ago, when I thought it was a top buy.
Should the recent run-up be a major deterrent for long-term investors, or is The Trade Desk still worth scooping up right now?
A unique model for a fast-changing digital-ad ecosystem
If you're like me and invest in multiple stocks in an emerging tech industry, you've had to "pull some weeds." Magnite (MGNI 2.72%) was my top bet that the supply side of the digital ad industry would consolidate. Companies like Magnite help sell ad inventory for publishers (a news network or a media company, for example). But my bet didn't pan out, and I sold my Magnite stock in late summer of 2022.
PubMatic (PUBM 2.59%) is another small sell-side platform that seems to be experiencing some delays in ramping up to more-robust profitability. I'm being patient with that one for now.
And then there's The Trade Desk, the emergent buy-side platform. It works primarily with advertisers, marketers, and their agents, like a consumer-products business that wants to target its ads to an audience it thinks might want to buy its goods. And The Trade Desk is proving its business model's merits.
On the surface, it would seem like the buy side of the digital ad industry would be just as chaotic as the sell side has been. This is so, because buy-side leaders include Alphabet's Google, Meta's Facebook and Instagram, Amazon, other top cloud-software names like Adobe and Salesforce (CRM 1.27%), Roku, and giant media conglomerates like Comcast.
Many of these giant companies operate their own sell-side and buy-side platforms to maximize the value of digital ad sales for themselves. So how can a (relatively) tiny company like The Trade Desk survive, let alone thrive?
I'll let The Trade Desk explain, as per the company's recently filed 2022 annual report:
We focus on buyers since they control the advertising budgets. Also, the supply of digital advertising inventory exceeds demand, and accordingly, we believe it is a buyer's market. We also believe that by aligning our core offerings with buyers, we are able to avoid conflicts of interest that exist when serving both the buy side and sell side. This focus allows us to build trust with clients, many of whom leverage their proprietary data on our platform.
A number of other factors also work in favor of The Trade Desk. There has been a massive increase in the number of consumer devices (PCs, smartphones, tablets, and more), a proliferation of apps, and a resulting explosion in data.
Marketers desire a single point of contact to simplify the way they reach their widely distributed audiences. And there's a risk for marketers in working with a big tech company: It might be working in its own interests as much as for the interests of marketing customers.
The Trade Desk is a one-sided software provider with no ad inventory of its own. It therefore claims status as an "enabler" for its marketing customers to obtain digital ads, rather than being a "disruptor" like its bigger competitors in essentially forcing marketing customers to choose from inventory with conflicts of interest involved.
The company's little gem of a paragraph above also explains the problems with investing in the sell side of the digital ad space (Magnite or PubMatic stock, for example). There's a plethora of advertising inventory across ever-growing media (web, mobile, traditional and streaming TV, and so forth). This makes the buy side the better profit center.
Plus, if you are a publisher with plenty of ad inventory to sell, it behooves you to spread out your spending across multiple sell-side platforms for two reasons. First, you need to make sure as many marketers as possible see what you have available. Second, there are the cost savings (though companies like Magnite and PubMatic have been saying for years that there's a little bit of consolidation going on here).
And many publishers use their own in-house sell-side software and connect directly with The Trade Desk's marketplace, again in the name of cost savings.
Basically, The Trade Desk has wormed its way into the digital ad space. It had $1.58 billion in revenue last year, which is still small potatoes considering global advertising is well on its way to $1 trillion a year. And it could have the very best business model to continue outperforming its peers over the long term.
The "steal of a deal" that may never come
In summary, The Trade Desk checks a lot of boxes for investors looking for a superior business to buy and hold for the long term:
- It participates in a growing industry benefiting from secular growth trends.
- It has a great business model that aligns with its customers' interests as well as its own.
- Its growth consistently outperforms its peers.
- It's highly profitable, with free cash flow of $457 million last year.
- Its balance sheet is clean ($1.4 billion in cash and short-term investments, with no debt).
This helps explain why the stock has persistently brought a very high premium for many years. Presently, the company is valued at 66 times trailing-12-month free cash flow.
Data by YCharts.
This high premium isn't going to jibe with many value investors. Even if the stock were to fall by 50% (it will invariably happen from time to time with any stock, let alone a growth stock), The Trade Desk isn't exactly going to look like a steal.
After all, net income according to generally accepted accounting principles (GAAP) is scant at the moment, mostly due to stock and stock options awarded to co-founder and CEO Jeff Green last year. Bear in mind that the bulk of these stock options haven't vested or been exercised yet, so some investors may be leery of the potential dilution that could become a problem down the road.
And while The Trade Desk's business continued to soar through industry issues in 2022, there is always the threat of an economic downturn dramatically hurting advertising spend. In tough times, marketing is often one of the first line items to be slashed. This could hurt The Trade Desk's progress in the future as well.
However, none of these issues are new for The Trade Desk. If you're waiting for a significant pullback so the stock is "cheap" before making a buy, you might be waiting for a time that never comes. If you like the business for the long haul but worry about valuation, consider buying in small batches or using a dollar-cost average plan.
I don't think The Trade Desk stock is as great a buy as it was just a few months ago, but I'm still more than happy to have this as one of my largest bets on the digital advertising market. I plan to hold for the indefinite future and will continue buying occasionally, as long as the thesis remains unchanged.
