It can be easy to look at a stock chart like The Trade Desk's (TTD 1.67%) and assume something is deeply amiss. Indeed, there's no denying the stock was priced at a high premium, much as it has been for the entirety of its existence. Even the recent post-third-quarter 2023 earnings update plunge hasn't fixed that. The Trade Desk currently trades for well over 50 times trailing 12-month free cash flow.
However, all individual stocks are highly volatile, and a high premium merely ratchets up that volatility. Under the surface of that stock price action and resulting headlines stemming from it, though, remains a high-quality business poised to deliver the goods for shareholders. Is it time to buy?
How long can the outperformance last?
The Trade Desk has been blowing away the growth rates of its big peers Alphabet and Meta Platforms for years -- on a revenue and free cash flow basis. Customers looking to migrate over their marketing and promotional activity to a digital format have loved The Trade Desk's status as a trusted partner, rather than purely a disruptor of the status quo.
Data by YCharts.
The Trade Desk kept up the pace in Q3 2023, posting year-over-year revenue growth of 25% to $493 million. GAAP net income more than doubled from last year to $39 million, and free cash flow through the first nine months of 2023 increased 43% to $485 million.
The big pain point investors were focused on, though, was CEO Jeff Green's and the top team's outlook for the fourth quarter. It takes into account a strong showing in ad spending on The Trade Desk's platform at the end of 2022, as well as macroeconomic uncertainty this year (Israel's war on Hamas in Gaza, lingering effects from auto worker union strikes, etc.). Green and company sandbagged a bit and said revenue should be "at least $580 million," implying at least an 18% year-over-year increase. Adjusted EBITDA (earnings before interest, taxes, depreciation, and amortization) profit has also been running at a 36% margin this year, but is nonetheless expected to get a seasonal bump to nearly 47% in Q4 (adjusted EBITDA margin was 50% in Q4 2022).
Overall, there's nothing to be too worried about. But again, with a high valuation comes some wild volatility in stock price. The Trade Desk is still in superb shape.
One way to handle growth stocks
If a high-growth business has the ingredients to deliver long-term outperformance, it stands to reason that a "premium" valuation will always exist. So how should investors handle a stock like The Trade Desk if they feel the company is a solid play benefiting from long-term secular growth trends?
Waiting for a great deal may leave you waiting for a very long time, and along the way, the market may keep rewarding business performance. If you have a long investment horizon and are a net saver, use a dollar-cost average plan to buy a stock like The Trade Desk.
Expect more bumps in the road going forward as The Trade Desk manages expectations for fast revenue and profit growth. Even after the recent tumble, this is still a richly valued stock. However, things look a bit more reasonable when factoring for forward expectations, as well as for the more than $1.5 billion in cash and investments and no debt on the balance sheet. The Trade Desk trades for 45 times enterprise value to Wall Street's early expectations for 2024 free cash flow -- which, to be honest, look very conservative to me, as they imply a mere 7% growth over 2023 free cash flow generation.
Save for a very small position in a digital ad software stock, as well as the tech giants Alphabet and Meta, I've closed out all my other bets on digital advertising except for The Trade Desk. I plan on adding to my position in this digital ads ecosystem leader after the Q3 2023 earnings update.
