For a business that is the lifeblood for its customer base, Toast (TOST 3.42%) has made for a pretty lousy investment. In 2023, when the S&P 500 and the Nasdaq Composite have both posted strong-double-digit gains, this fintech stock is down 15% year to date. Moreover, the mid-cap company's shares are currently 76% below their peak price. That's not really encouraging.
It's not all bad news, though. In fact, there are compelling reasons why Toast might be a worthy investment candidate right now. Here's what you need to know.
Making it easy for restaurants
The best way to describe what Toast does is to think of its products and services as being like the operating system for a typical restaurant. Not only does Toast sell hardware, like point-of-sale systems and kiosks, but also the necessary software to help restaurant owners better manage their operations. Key features include payment processing, employee payroll and scheduling, loyalty programs, and working capital loans.
What's important to focus on is the clear value proposition that Toast offers. A restaurant might have to use software and services from various providers that do not integrate which each other, are difficult to use, and are costly. By being built specifically for the unique needs of restaurants, Toast's end-to-end solution makes things much easier.
The data backs this up. Approximately 20% of new customers are brought on by referrals, the most powerful marketing tool around. That speaks to how impressive Toast's offering is. And in 2022, the company reported a net revenue retention rate of 118%. Anything above 100% is great as it indicates customers are satisfied enough to stick around. All signs point to incredible product-market fit.
According to the management team, there is a lot of potential over the long term. In the U.S. alone, there are 860,000 restaurant locations generating more than $900 billion in sales annually. Executives say Toast has about 10% of the market based on locations. Add this to the trailing-12-month revenue of $3.6 billion, and there is sizable financial upside.
Protecting itself from rivals
It's not surprising that a fast-growing software-based niche like this would invite stiff competition. The most notable rival is Block, specifically its Square segment. From the customer's perspective, though, Toast appears to have a leg up, mainly because it focuses exclusively on restaurants and their needs.
This means a complete set of features, like 24/7 customer support, comprehensive online ordering capabilities and integrations, and better reporting tools. A new mobile app called Toast Now, which allows owners and operators to keep tabs on what's going on with their restaurants from any location, also demonstrates ways the business is bolstering its offerings.
Toast also benefits from having an economic moat, which protects its competitive positioning. The most obvious is the presence of switching costs. Restaurants that are on Toast's platform aren't likely to switch providers because of the massive headaches it would likely cause.
And just think about the tremendous amounts of data that Toast is collecting, like what types of cuisines are the most popular, what times of the day demand is not being met fully, or what consumers' favorite ordering channels are. This business is definitely building a data advantage that could help management inform product innovations, while at the same time adding value to restaurants and their ability to make decisions.
Some red flags
Investors will probably find Toast's current price-to-sales ratio of 2.3, which is less than half the historical average of 5, to be a compelling enough reason to buy shares today, especially considering the points I made above. But it's best not to ignore two red flags.
It's not surprising that a business in the early stages of growth -- like Toast -- has yet to produce positive net income in any fiscal year. Another worrying sign is the ballooning outstanding share count, which has soared 167% in the last three years. This dilutes existing investors.
Even with these unfavorable aspects in mind, it's easy to still be optimistic about Toast. And this might warrant starting a tiny position in the stock and holding for the long term.
