The phrase "You get what you pay for" rings true in many areas of life. Whether it's buying appliances, a vehicle, or a stock in the market, it's an adage that seldom wavers. It's also something investors should remember when examining a stock like The Trade Desk (TTD 3.35%).
While the stock looks incredibly expensive, it's one of the best executors in the software industry and has a massive market it's trying to capture. Still, even the best companies bought at the wrong price can make for terrible investments. So is The Trade Desk too expensive to buy right now? Let's find out.
The Trade Desk is revolutionizing the advertising market
The Trade Desk is focused on bringing advertising technology to the digital age. Traditionally, this has looked like targeted ads in the margins of web pages, but The Trade Desk's offering is much greater than that. Advertisers can place content in the best locations on mobile devices, audio (like podcasts), and connected TV with its tools.
Because The Trade Desk is using its cookie replacement, Unified ID 2.0 (UID2), it can accurately provide data to advertisers about its users on devices with no search history (like a smart TV). Furthermore, because the technology uses an anonymous ID associated with an email address, it's more secure as it can't associate sensitive information with a customer, only an ID.
This technology will drive change in one of the largest ad markets: Connected TV. Linear TV ad revenue is projected to reach about $165 billion in 2023. With more people switching to a digital model, it opens the door for advertisers to cater the commercial break content to its viewers. Because it's not an ad for a blanket audience, these ads are more expensive and are nearly double the cost per thousand (CPM) of a traditional ad. This shows the appetite for targeted advertising, and The Trade Desk is set to cash in on this shift.
The Trade Desk's business is solid, but do its finances back it up?
The growth implied by its valuation will be hard to achieve
Unlike many software companies, The Trade Desk has consistently produced profits. In first-quarter 2023, The Trade Desk produced $9 million in net income against revenue of $383 million. While that's not a massive profit, it is also affected by a $60 million long-term performance grant to CEO and founder Jeff Green. This isn't technically a recurring expense, so it's a bit easier to add that $60 million back into the net income figure to assess The Trade Desk's profitability potential.
Even in a weak advertising market, The Trade Desk's 21% revenue growth is impressive, and it shows how important its platform has become to ensuring advertising dollars are spent efficiently. With about $1.3 billion in cash and short-term investments on the balance sheet and no long-term debt, its balance sheet is also squeaky clean.
It's The Trade Desk's robust business model and impressive finances that earn part of its premium. But with Wall Street analysts expecting revenue growth of 22% and 25% in 2023 and 2024, respectively, its future potential makes up the other half.
So just how expensive is The Trade Desk?
TTD PS Ratio data by YCharts
With its valuation holding steady above pre-COVID-19 highs, it's an interesting case study. At 20 times sales, the valuation level is quite high for its relatively slow growth (compared to other companies that have achieved a 20 times sales valuation).
Furthermore, it implies that The Trade Desk must grow consistently to make sense. If you take its all-time best profit margin of 29% and apply it to its current price-to-sales ratio, it would imply a 70 times earnings valuation if The Trade Desk was at peak profitability.
For this best-case valuation to reach a more reasonable level, say 30 times earnings, The Trade Desk must grow its revenue by 20% annually for about five years without any stock price growth. Essentially, you're paying for a flat return over the next five years in exchange for what The Trade Desk can do afterward.
While I can't make that call for you, it's a serious risk investors must consider. However, the changes that The Trade Desk is making to the advertising industry are fundamental at its core, so it will maintain a relevant investment for much longer than five years. Because of that, I think it's a stock worth considering. Still, investors should keep the position sizing relatively small and be ready to pounce once a more attractive valuation point arrives.
