The Trade Desk: Zooming Out On Its Valuation (NASDAQ:TTD)

Introduction

The Trade Desk (NASDAQ:TTD) has achieved amazing returns over the past decade. The stock rose 1390% (31% annualized), compared to the S&P500 of “only” 100% (7.2% annualized). The stock has been under pressure since the beginning of the year due to high inflation and the Fed’s measures to dampen high inflation. Investors were also concerned about Apple’s (AAPL) measures to protect consumer privacy by allowing consumers to choose whether they want targeted ads. The Trade Desk does not expect the change to have a material effect on its business. Fed rate hikes are lowering asset prices in general, and the stock is down 60% from its all-time high.

Valuation numbers show a mixed picture, but analysts expect strong growth in the coming years. Investors can still earn good returns on the stock.

The Trading Desk Operates In A Massive TAM

The Trade Desk provides a platform for buyers in the advertising space. Customers can be advertising agencies, brands or other technology companies. The company was founded in 2009 and saw strong growth in the following years. In 2021, the company generated $1.2B in revenue, including $456M in adjusted net income. The company is highly profitable, as its adjusted net income margin is 42%.

Revenue increased 43% in 2021 and grew 43% on average over the past 5 years. The Trade Desk operates in a huge total addressable market (TAM), as TAM is approximately $816B in global ad spend. TTD’s platform is used by many large companies, diversified across all major verticals.

The Trade Desk posted strong results in the third quarter, with 31% more revenue and 33% more EBITDA year-on-year. Net income declined due to share-based compensation. CEO Jeff Green spoke encouraging words for 2023 and beyond:

While I don’t often comment on competitors’ performance, I do think it’s worth noting again that in an environment where many of our competitors contracted or grew in the single digit range, we grew 31 percent. That shows that we are outperforming the market and that we’re gaining share, even in what many are calling a challenging macro environment. While we will never be immune from those macro challenges, we are confident that we will continue to outperform.

The Stock Could Still Deliver A Good Return

The Trade Desk is a strong growth stock with a depressed price. As revenue and earnings estimates have been revised upward by 13 analysts, the company is still in growth mode. Besides growth, the stock’s valuation is important; the stock could not increase to infinity.

The company is still growing strongly and has a high gross margin of over 80%. So I am trying to take a different approach rather than charting the PE ratio, price to free cash flow ratio, etc. Instead, I charted the PS ratio and compared its value to its historical value, plus I try to gain insight into the general stock market for companies with gross margins over 80% and sort them by their PS ratio.

YCharts shows the following PS ratio chart, and the P/E ratio of 14.9 looks favorable compared to its 3-year average PS ratio of 31. The stock has been in a strong bull rally since the corona crisis until early 2022 due to the closure of physical stores; advertising revenue saw a sharp increase as online spending increased significantly.

Excluding the PS ratio from 2020 to now, we see that the 3-year average PS ratio from mid-2016 to 2020 is about 9. Now that physical stores are open again, e-commerce growth has stabilized to normal levels, and the stock should be trading at normal levels again (at a PS ratio of 9). The stock currently appears overvalued compared to historical figures (excluding post-corona growth). Still, strong sales growth is expected in the coming years.

With strong growth numbers included, the valuation figure looks different. 5 analysts on the Seeking Alpha TTD ticker page expect revenue of $3.1B at the end of the fiscal year 2025. If we multiply this number by the average PS ratio of 9, we arrive at a market cap of $28B. Currently, the market cap is $22B, which means the average expected stock return is 8.4% per year. The company must achieve the high expected growth numbers, and if it fails to do so, the stock may crash.

Lastly, to gain insight of the overall market, I used Finviz and filtered stocks based on the following criteria:

• Market cap larger than $2B
• Gross margin over 80%
• Sales growth quarter-over-quarter over 30%
• Price to sales ratio over 10

The following table was created and sorted by price to sales ratio. The Trading Desk is number 10 on the list of 22. It should be noted that the list includes REITs, which should be excluded because their activities are totally different from those of TTD.

The list tells us that TTD trades around the median of all PS ratios from the companies in the list. The companies in the list range from tech companies, pharmaceutical companies, REITs, etc. Making a comparison is comparing like apples to oranges. But it gives a good overview of the market as interest rates rise. Rising interest rates are detrimental to growth stocks.

The Trading Desk’s valuation appears moderately expensive compared to its historical numbers and trades at the median of the general market. The company continues to grow strongly, and if it lives up to expected growth, investors could earn 8.4% annually. The stock is worth buying.

Conclusion

The Trade Desk delivered astonishing returns of 31% per year over the past decade. The stock is currently under pressure from rising interest rates and uncertainty about measures by Apple. The Trade Desk does not expect that the change will have material impact on its business. TTD operates in a huge advertising space with a TAM of $816 in global ad spending. The company increased its revenue by an average of 43% over the past 5 years. Third quarter results were strong, and the CEO expects growth to continue in 2023 and beyond. Although the stock’s valuation appears pricey at first glance, the stock is valued in line with the market. Historically, the valuation is on the high side, but taking into account the strong earnings growth prospects for the coming years, investors could expect a good stock return.