The Trade Desk: A Compelling Investment For Aggressive Growth Seekers (NASDAQ:TTD) (2024)

The Trade Desk (NASDAQ:TTD), a company providing the ad industry with a cloud-based platform that assists marketers in digital advertising purchases using automated real-time ad impression bidding, is one of the few cloud stocks performing well in 2024. There are several secular tailwinds responsible for this advertising platform's outperformance, including TV viewers continuing to adopt streaming, ad dollars following those viewers to streaming platforms, the industry's growing adoption of the privacy identifier UID 2.0, and the ad industry slowly moving away from closed advertising markets like Alphabet's (GOOGL)(GOOG) Google and Meta Platforms' (META) Facebook.

Since I last wrote about the company on January 4, 2024, by giving the stock a strong buy recommendation to start the new year, the company has reported fourth quarter 2023 and first quarter 2024 earnings results. Although it missed analysts' revenue and earnings-per-share ("EPS") estimates in the fourth quarter, the company reported solid numbers in the first quarter, beating analysts' revenue estimates by 2.2% and EPS estimates by 20.74%. Also, management's revenue guidance for the second quarter of 2024 of $575 million exceeded analyst estimates of $567.1 million. The stock is up 43.26% since Seeking Alpha published my last article, compared to the S&P 500 Index, which was up 17.09% over the same period. The following chart shows the year-to-date results until the June 19 market close.

This article will examine the ad industry's ongoing adoption of UID 2.0 and how it benefits The Trade Desk. We will also investigate how Connected TV ("CTV") is moving towards open platforms and how it has brought more partnerships with large content providers to the company. The article will also briefly review the company's first quarter 2024 results and examine a few risks. Last, the article will discuss why aggressive growth investors can still buy the stock despite the valuation being at what some might consider nosebleed levels. I am downgrading the stock from Strong Buy to Buy.

The ad industry's adoption of UID 2.0

In my previous article on this company, I briefly explained that Google's plan to phase out third-party cookies this year could obsolete ad targeting based on third-party data. If The Trade Desk failed to produce a backup plan to create a privacy-focused identifier, it could and would seriously damage its business prospects once Google implements its plan to eliminate third-party cookies.

Google's plan to turn off third-party cookies in Chrome is likely not rooted in an altruistic plan to protect user privacy. Turning off third-party cookies could hurt all of Google's ad competitors that use cookies for ad targeting, while Google would still retain the capability to identify users. Google plans to replace cookies with a privacy sandbox within Chrome. Critics have already accused its proprietary sandbox solution as a way for Google to dominate the ad industry further. An opinion piece posted on the website "Movement for an open web" states the following about Google's privacy sandbox (emphasis added):

The whole basis of Google's Privacy Sandbox project is undermined. It was introduced as a means of enhancing user privacy by removing control over interoperable match keys from most businesses other than Google. However, if – as the above suggests – these match keys are used by organizations with appropriate safeguards to mitigate any privacy issues then the logic of the project fails. In fact, it reveals the sandbox for what it truly is – an attempt by a monopolist to remove safe and interoperable technologies (e.g., the cookie) and replace it with a system that is owned and controlled by the company itself.

In contrast to Google's privacy sandbox idea, Unified ID 2.0, also called UID 2.0 or UID2, when fully established, should be a non-proprietary, open standard solution available for all companies in the ad industry to use instead of benefiting only one company. The Trade Desk invented UID 1.0, a universal cookie, around 2018, when Google began following on the heels of Apple's Safari and Mozilla's Firefox browser's plans to prevent third-party cookies from tracking users. The Trade Desk later replaced the universal cookie idea with UID2 and began signing up partners for the new ID in October 2020. Fast forward to today, UID 2.0 has a multitude of publishers, programmatic platforms on both the buyer and seller side, data providers, and clean rooms.

UID2 benefits marketers by allowing them to use the data they collect directly from their users (first-party data) to create a privacy-preserving identifier (UID2) that they can use on publisher (content creator) websites that have joined the UID2 framework to improve ad targeting and measure ad campaign results. User privacy is not compromised because the first-party data remains with the marketer and is not transferred to the publisher.

Chief Executive Officer ("CEO") Jeff Green likes discussing how companies that use UID2 with The Trade Desk's AI products have superior outcomes compared to third-party cookies during its earnings calls. On the first quarter earnings call, Jeff Green said (emphasis added):

More and more advertisers are prioritizing ad opportunities where they can be sure they are reaching their target audience. And increasingly, that means activating their first-party data effectively, and leveraging ad impressions where UID2 is present. This is the new identity fabric of the Internet taking shape, and it's revaluing the Internet in the process. Recently, Target Australia and their agency OMD worked with us to upload their first-party customer data into our platform, then, targeted new customers using UID2.Their conversion rate improved 66% versus using traditional identifiers, and their cost per action decreased 36%.

A conversion rate measures the percentage of users who have completed a designated action. A designated action might be clicking on an ad or making a purchase. A cost per action is how much marketers pay publishers when a user takes a designated action. So, what Jeff Green is saying in simple terms in the above statement is that Target Australia got more bang for the buck using UID2 with The Trade Desk's ad tech technology than traditional identifiers like third-party cookies. If you ever wonder why its solutions are so popular in the ad marketplace that the company can consistently produce +20% revenue growth in a terrible ad market, it's because The Trade Desk delivers one of the best Return on Investment for ad dollars for its marketing clients.

CTV forming a tidal wave

Alphabet and Meta Platforms have been the kings of digital advertising over the last decade and a half. However, there is evidence that both companies' influence on the digital ad market has declined. CEO Green said on the first quarter 2024 earnings call, "In 2022, that marked the first year in a decade that the majority of digital ad spending took place outside of Meta and Google." The Trade Desk is a huge beneficiary of the ad industry slowly moving toward open ad platforms and away from Google and Facebook. These two behemoths use a closed platform to control the content, data, and ad targeting criteria and set the prices and terms at which marketers can buy ads on the platform. Some call this a "walled garden" approach. This walled garden approach has brought wealth to investors in Alphabet and Meta. However, their practices have been disadvantageous to marketers throughout the years, and the rise of more open platforms on CTV gives marketers a more advantageous way to advertise.

CTV and programmatic advertising became prominent during the pandemic. CTV is the ability to use the Internet to stream content to a TV. It is more easily digitized than the traditional scheduled TV delivered via satellite, cable, or airwaves. One reason why CEO Jeff Green has referred to CTV being a tidal wave in the past is that CTV is disrupting the traditional TV model and advertisers are following users to the world of streaming. According to the marketing company Stirista:

CTV ad spend has increased by almost 400% since 2019. And while CTV advertising grows even beyond initially high expectations, linear TV ad spend continues to decline. According to Insider Intelligence, linear TV ad spend will fall from $61.31 billion in the US in 2023 to $56.83 billion in 2027. All the while, CTV will increase from $25.09 billion in 2023 to $40.90 billion in 2027.

And unlike the internet advertising dominated by Google and Meta, it's increasingly unlikely that one or two colossal companies can build a closed platform that is disadvantageous to ad buyers on CTV. When CEO Jeff Green refers to the "open internet" in his communications with investors, he is talking about the opposite of the walled garden approach. Open internet platforms on CTV allow the marketplace to set the terms and prices for advertising, and the ad buyers (marketers) have more control over their data.

The second reason Jeff Green refers to CTV as a tidal wave is that more content owners have concluded that it is not in their best interest to attempt to create a walled garden. On the company's first quarter 2024 earnings call, Green discussed expanding The Trade Desk's partnership with The Walt Disney Company's (DIS) to include integrating Disney Advertising Real-Time Ad Exchange with The Trade Desk's OpenPath, which should help Disney sell more ads on Hulu and Disney+. Another company turning away from the walled garden approach is NBCUniversal, a subsidiary of Comcast (CMCSA), which is opening up access to its CTV ad inventory through The Trade Desk for the U.S. Olympic Trials, Olympic, and Paralympic Games.

In the early days of CTV, it looked from the outside like Roku (ROKU) was flirting with creating a walled garden ecosystem on CTV. After all, it purchased a rival ad platform to The Trade Desk named dataxu in 2019. At the time, some thought Roku might end or limit advertising deals with Adobe (ADBE) and The Trade Desk. However, Roku recently turned away from flirting with the walled garden model. At the end of April this year, Roku partnered with The Trade Desk. CEO Jeff Green discussed the partnership on The Trade Desk's first quarter 2024 earnings call:

I think it makes a ton of sense for Roku to embrace the open Internet with their premium content. Early on, when CTV inventory was scarce, it made sense for many of the premium CTV streamers to sell most of the inventory themselves. With the proliferation of CTV content over the last couple of years, those same companies now need to find ways to maximize advertiser demand, and that means opening up to a broader range of demand sources such as The Trade Desk and embracing solutions such as UID2, which help advertisers find their target audience as accurately as possible. We are excited to be Roku's partner in this, and we believe this move is a win-win-win for Roku, for advertisers, and for The Trade Desk.

In other words, he is saying that as more content moves to CTV, there is increased competition to fill ad spots. Over time, Roku likely found it challenging to fill all of the ad slots in its inventory itself. The best way to monetize those ad slots was to let other third-party companies like The Trade Desk help them sell their ad inventory.

Currently, Amazon (AMZN) Prime Video is using what looks like a walled garden approach. However, even the mighty Amazon might encounter serious roadblocks in establishing a walled garden on CTV. CEO Green also discussed Amazon on the second quarter earnings call:

So today, we don't buy Amazon Prime Video [ads]. That's only available from Amazon selling it themselves. And as you point out, I believe they're adding a significant amount of supply, but then only selling it themselves, which does put some pressure on the objectivity problem that their DSP [Ad buying platform] in particular has. And when, I say the objectivity problem, I mean, it is very difficult to go to a buyer and say, give me your money and I will help you objectively figure out where to put it. And by the way, I own a lot of it [content]. And so, I would, of course, bias towards selling my own [content]. Everybody who does that tends to have a problem when they're repping other people's [ad] inventory, and it makes it difficult for them to partner with. But their objectivity problem that I just described is -- could also be similar to a Google or somebody else, but they take it even one-step further, which is that, at Google, they don't make products that compete with all of these people that are selling. And because they white label soap and baby wipes and diapers and whatever else at Amazon, that also competes with many of the CPGs [consumer packaged goods] who are doing all the advertising.

Jeff Green is saying in the above commentary that Amazon has several conflicts of interest. One conflict of interest is that Amazon owns a lot of content on Prime Video and may be biased towards selling ad slots on its content instead of putting ads in the best ad slot for the advertiser. Amazon's second conflict is that it competes against some potential advertisers by selling a rival product in its e-commerce marketplace. Amazon has no incentive to place a rival's product in the best ad slot. However, selling ad slots may be difficult if advertisers find superior results elsewhere. Jeff Green later said on the earnings call that he thinks Amazon will eventually open its ad inventory to third parties. By opening up its ad inventory, Amazon could eliminate these conflicts.

There is substantial momentum behind an "open internet," and this tidal wave of more companies embracing opening up their ad platforms to third-party ad-buying networks creates a fairer system for advertisers and is a tailwind for The Trade Desk's programmatic ad platform.

Review of The Trade Desk first quarter 2024 results

The Trade Desk grew revenue by 28% over the previous year's comparable quarter to $491 million, exceeding company guidance of $478 million. CEO Jeff Green stated in the first quarter earnings release:

Our outstanding performance to start the year underlines the value advertisers are placing on premium inventory on the open Internet...With the continued strong growth of CTV, the growing ubiquity of UID2, new approaches to authentication, greater deployment of first-party data and retail data, and with significant AI advances in our Kokai platform, we are better positioned than ever to deliver premium value to advertisers and continue to gain market share.

The company's annual revenue increased at a compound annual growth rate ("CAGR") of 52% between 2014 and 2023. The following chart shows Annual and quarterly revenue growth.

One number that investors monitor every quarter is the company's customer retention rate ("CRR"), which has remained steady at over 95% over the last ten years. CRR is a measure of customer loyalty and is the number of customers a company retains over a specific period expressed in a percentage. This number is significant, and if you see it trending downward, it means that The Trade Desk is losing customers. Since the CRR has been above 95% since the company came public in 2016, the market would likely react negatively to any reported CRR number below 95%.

The following image from the company's first quarter 2024 10-Q shows The Trade Desk's first quarter GAAP (Generally Accepted Accounting Principles) income statement:

Most of the reason that The Trade Desk achieved an operating profit in the first quarter of 2024 as opposed to last year's first quarter's operating loss is because General and Administrative expenses were lower, mainly due to a decrease in stock-based compensation ("SBC") caused by how the company accounted for a CEO Performance Option. The company's 10-Q states, "The decrease in stock-based compensation was primarily driven by a $24 million decrease in expense related to the CEO Performance Option driven by the graded-vesting attribution method, under which more expense is recognized earlier in the option's life, partially offset by a $6 million increase in expense related to new equity grants." The potential for the company's GAAP profitability numbers to jump around quarter to quarter is high based on how the company accounts for SBC.

One thing that may turn some investors off to The Trade Desk is that it has a relatively high SBC as a percentage of revenue. The table below compares the company's SBC to several other companies in the programmatic ad industry.

The following image from The Trade Desk's first quarter 2024 earnings release shows how much SBC adds to operating expenses:

Because SBC expenses can be inconsistent from quarter to quarter, management prefers to emphasize non-GAAP metrics during earnings calls. Chief Financial Officer Laura Schenkein said the following on the first quarter 2024 earnings call about expenses:

Q1 operating expenses, excluding stock-based compensation, were $352 million, up 20% year-over-year. We continue to make investments in our team and platform, particularly in areas like sales and marketing and platform operations as we position the organization for long-term growth. Income tax expense was $14 million in the first quarter, driven primarily by our profitability and non-deductible stock-based compensation.

Notice that despite excluding SBC expenses, The Trade Desk is investing heavily to maintain revenue growth. Although the company is not a "growth at all costs" company, with the size of the opportunity ahead of it, management emphasizes growth over profitability, and SBC is part of that calculation. The company pays its employees very well, including the CEO. In 2021, Jeff Green received a massive compensation package with an estimated $828.4 million in stock options. Investors in The Trade Desk must become comfortable with the company's use of stock options to attract high-quality workers.

The company generated a first-quarter 2024 non-GAAP adjusted net income of $131 million, up 15% over the previous year's comparable quarter. Non-GAAP diluted EPS was $0.26. Adjusted EBITDA was $162 million, beating the company's first-quarter guidance of $130 million.

The chart below shows that free-cash-flow ("FCF") was $176 million during the quarter. Trailing 12-month ("TTM") FCF was $543 million.

The company has an excellent balance sheet with $1.4 billion in cash and short-term investments at the end of the first quarter, with no debt on the balance sheet.

Management's second-quarter 2024 revenue guidance calls for $575 million, an increase of 24% year-over-year if the company hits that mark. One reason bullish investors believe The Trade Desk can sustain a quarterly year-over-year growth rate above 20% is that it has barely scratched the surface of its total addressable market ("TAM").

If you believe the company's TAM is only digital media, excluding search (Google) and social media (Facebook), its $2.06 billion TTM revenue has only penetrated 1.5% of a $135 billion TAM. However, if you believe the ad world will eventually be 100% digital, The Trade Desk has only penetrated 0.22% of a total addressable market of $900 billion. As long as this company maintains its status as one of the most well-run ad-tech platforms, it should have plenty of room to grow its top line.

Management's second-quarter 2024 guidance calls for approximately $223 million in adjusted EBITDA (earnings before interest, taxes, depreciation, and amortization), up 24% year-over-year if the company hits the mark. If the company hits its revenue and EBITDA guidance, its EBITDA margin will be 38.8%, the same as the previous year's second quarter. So, although the company emphasizes growth over profits, it spends reasonably and retains its core profitability.

Risks

Although CEO Jeff Green constantly talks UID2 up during earnings and often announces new publishers, data providers, and ad-tech providers adopting UID 2.0, he doesn't talk about two additional things that UID2 needs to become a viable industry standard: It needs to recruit an independent operator and find an entity to serve as a core administrator.

The UID 2.0 website describes a core administrator as the following (emphasis added):

An organization (currently, The Trade Desk) that manages the UID2 Core Service and other components. For example, it distributes encryption keys and salts to UID2 operators and sends user opt-out requests to operators and DSPs.

The UID 2.0 website also describes an operator as the following (emphasis added):

Organizations that run the Operator Service (via the UID2 APIs). Operators receive and store encryption keys and salts from the UID2 Core Service, salt and hash personal data to return raw UID2s, encrypt raw UID2s to generate UID2 tokens, and distribute UID2 token decryption keys. Open operators run public instances of the Operator Service. For example, The Trade Desk currently serves as an open operator for the UID2 framework, available to all participants. If other open operators are available, a participant can choose which operator to work with. Any participant can also choose to become a private operator to generate and manage UID2s.

Advertisers, publishers, agencies, and other ad networks may view UID2 as simply a biased arm of The Trade Desk, and adoption of UID2 could slow, limiting the effectiveness of the privacy initiative until it has a core administrator and independent operators other than The Trade Desk. Several years ago, some thought IAB Tech Lab would take on the administrator role. However, the Board of that non-profit consortium nixed that idea in 2021. IAB Tech Lab CEO Anthony Katsur stated the following in a blog:

Tech Lab has decided it will not be taking on the technical administrator role for UID 2.0 at this point. Tech Lab is amenable to revisiting the role of running any necessary global infrastructure at a future date.

IAB Tech Lab is waiting for broader industry adoption and further development of UID 2.0 technical specifications before deciding to take on the administrator role. Additionally, an open-source advertising standards body, Prebid, chose not to become an independent public operator until The Trade Desk found an independent core administrator. So, investors should remain aware that UID2 has yet to become an industry standard. If UID2 ultimately has less effectiveness than The Trade Desk originally envisioned because it could not find an administrator and operator, it could hurt its business as it built many of its AI systems and ad technology to use UID2.

The Trade Desk has multiple competitors waiting for it to trip up, including Adobe, Microsoft, LiveRamp, Quantcast Platform, Amazon, and Google. Some of the above companies also have greater name recognition and financial resources. Its programmatic ad platform business doesn't have a moat, so conservative investors may want to avoid the stock at its current valuation. The company will likely also need to continue investing significantly in the near term to maintain its revenue growth.

Last, the market considers CEO Jeff Green a visionary and likely reason that The Trade Desk is one of the best-run and technically adept companies in the ad-tech business. If Jeff Green ever leaves the company, some of the allure of investing in the stock may wane.

Valuation

The Trade Desk's price-to-sales (P/S) ratio is 23.75, a little above its five-year median. Based on this information, some might conclude that the market is slightly overvaluing the stock.

If you compare The Trade Desk's P/S ratio to several popular software or cloud platforms, it looks overvalued. Still, its P/S ratio aligns with several companies the market has identified as some of the biggest beneficiaries of Artificial Intelligence: Palantir (PLTR) and CrowdStrike (CRWD). Some perceive The Trade Desk as a beneficiary of AI, which it uses to improve advertising results on its platform. Therefore, there may be some AI premium in the stock.

The Trade Desk's price-to-FCF is 89.96, below its five-year median of 96.06, suggesting the market may undervalue the stock.

Let's examine a reverse DCF on the company to determine what its stock price implies about its FCF growth over the next ten years and whether that growth is realistic.

The Trade Desk Reverse DCF

At least one analyst expects The Trade Desk to grow revenue at a CAGR of 15.26% over the next ten years. At least two analysts expect the company to increase revenue at a CAGR of 20.81% over the next five years. Analysts forecast the company to grow its FCF at a CAGR of 21.58% over the next three years. Those growth rates don't inspire confidence that The Trade Desk can grow its FCF at 28.7% over the next ten years.

Considering its history, The Trade Desk should average around 29% FCF margins over the next ten years. At FCF margins of 29%, the company would need to grow FCF at a rate of 27.5% to justify the June 17 closing price. Suppose the company grew its FCF at 15.26% over the next ten years at an FCF margin of 29%; the estimated intrinsic value would be $40.80. If the company grew its FCF at 21.58% at an FCF margin of 29%, the estimated intrinsic value would be $64.38. Both numbers are well below the June 17 closing stock price of $97.68. It would be hard to justify buying the stock based on potential FCF growth. However, remember that The Trade Desk is in growth mode and once it focuses on profitability, its FCF margin and FCF growth may be higher than my assumptions in this DCF.

Let's look at its forward price-to-earnings (P/E) ratio.

The Trade Desk's forward P/E ratio for fiscal years 2024, 2025, and 2026 exceeds the EPS year-over-year growth rate for those corresponding years, suggesting overvaluation. However, in the years beyond 2026, its EPS growth rate exceeds its forward P/E. If the one analyst who estimated those growth rates in 2027 and beyond is correct, the market may undervalue the company's EPS growth rates after 2027.

On June 17, 2024, Wedbush initiated The Trade Desk with an outperform rating. A Seeking Alpha article reporting the upgrade stated, "Analysts led by Scott Devitt noted that they see multiple drivers for the company's sustainable and over 20% topline growth." The company has high odds of growing revenue and EPS for a sustained period in the 20% range. So, although several valuation metrics are flashing red in the short term, the possibility exists that if the company maintains around a 20% growth rate over the next seven or eight years, it may grow into its valuation. Therefore, if investors buy into this stock at current prices, they should be prepared to hold it for five to ten years.

Why the stock is a buy for aggressive growth investors

The market may overvalue this stock in the short term, and it is at high risk of declining if it misses analysts' revenue or EPS estimates or otherwise disappoints. As a result, conservative investors may want to avoid this stock. However, it's not fait accompli that the stock will drop soon due to underperformance. This company has a history of mostly outperforming expectations. The Trade Desk has a solid potential to grow into its valuation over the next several years. Aggressive growth investors can still buy the stock if they intend to hold it for the long term. I am reducing my rating from strong buy to buy.

I have been a Merchant Seaman that has traveled the world for over 30 years. Within the last 15 years, I developed a very intense interest in investing. I learned a lot of what I know about investing from The Motley Fool. Also because I have a engineering background, I often tend to gravitate to Tech stocks