Investors didn't seem to have much appetite for restaurant software specialist Toast (TOST 3.42%) in 2023. The stock ended the year essentially flat although that's certainly better than a loss.
When investors aren't sure what to think about a stock, that could spell opportunity. It could also mean high risk, though, or a value trap. No doubt, there is a large amount of competition in its industry. But Toast's biggest competitor is a name you might recognize, and it might surprise you.
Why Toast is becoming popular
Toast markets automated software for restaurants that takes care of all of a restaurant's operational needs in one place using cloud-based technology. It handles back-end processes like accounting and wages as well as front-end services like menu creation and payment processing.
It's not hard to imagine why restaurants are flocking to these kinds of services, and Toast is demonstrating high growth. It uses annualized recurring run rate (ARR) as its top-line growth metric, and it increased 40% year over year in the 2023 third quarter. Its client count increased 34% to 99,000. Its net loss totaled $31 million, an improvement over its $98 million loss last year, and it generated positive free cash flow of $37 million, after an outflow of $80 million last year.
Does Toast have an edge?
Toast has momentum, but there's industry-wide momentum as restaurants see the benefits of moving toward automated processes. Toast says it has an edge over competitors because it has wider capabilities to handle various kinds of digital orders as well as 24/7 customer service for all packages.
Another reason Toast says clients switch over to its services is that they're purpose-built for the restaurant industry, in contrast with other companies that offer similar solutions for any kind of small business. The restaurant industry is one of the largest globally, and Toast's vertical services address pain points that target this niche so clients don't have to put the effort into creating plans that work for their businesses.
That's why it's interesting that it says its biggest competitor is none other than Block (SQ 2.32%), especially the Square sellers business that gave the company its original name. Square provides a large suite of small business solutions that are comprehensive and easy to use, and it's reporting robust growth.
Square works for any kind of small business, and it's focused on flexibility and providing a localized experience for its customers. It offers hardware and software solutions that meet restaurant needs, even though it doesn't only target restaurants. These include easy-to-use point-of-sale systems with integrated payment processing, data analytics, kitchen displays, and online ordering. Square says that it's "quicker, easier, and more user friendly" than its competition, including Toast. Its clients include high-profile names like Shake Shack and Ben & Jerry's (owned by Unilever).
Toast touts its no. 1 spot as found in G2, a third-party aggregate reviewer. It scores high in both satisfaction and market presence, making it a leader, while Square is a bit behind in market presence because it's a general retail solution provider. That does give Toast an edge, because it's able to reach its target market more effectively.
However, according to some client experiences, Square is just as efficient. It speaks to Square's flexibility as a small business platform that it can be used so effectively in the restaurant industry despite not being built exclusively for restaurants.
Toast stock looks tasty
There's room for more than one solutions provider in this industry, and competition is always good for the customer.
Both Toast and Square are capturing market share and expanding their client bases, and they could both be excellent buys this year. Toast's profitability is improving, and I'm anticipating 2024 guidance when it reports fourth-quarter results. If it can continue to grow by double digits and become profitable, its stock should soar this year. It trades at the low price-to-sales ratio of 2.7, and while there's risk, that looks like an excellent entry point for a stock that could provide years of gains.
Block is in a similar boat. It got distracted over the past few years with new business segments and has been posting net losses. But it has popular products, and management appears to be committed to returning to its core activities. Block stock trades at 2.3 times trailing 12-month sales, and I would only recommend it for highly risk-tolerant investors.
