The Trade Desk’s Moat Is Wide, But Also Vulnerable To Attack (NASDAQ:TTD)

I consider The Trade Desk (NASDAQ:TTD) to have quite a wide moat at the moment in diverse, unified access to digital marketing platforms, supported by its strong reputation and scale of operations. However, I also consider its position in the market to be quite delicate at a time of radical innovation in machine and deep learning. As such, while the valuation at the moment looks fair to me, I am cautious about allocating to the company as I wonder whether the firm will serve me well in my portfolio over many decades, which is my typical investment horizon.

Operations Analysis

As a leader in digital advertising, many investors look to The Trade Desk as an opportunity to invest in future-oriented technology that should be instrumental in laying the foundation for new marketing efforts. The Trade Desk offers advertising across display, video, audio, digital out-of-home, and social media, all from one unified interface.

Crucial to its business model is its programmatic advertising, which enables advertisers to purchase advertising space through automation and algorithms. This is a massive benefit over the old manual negotiations and preset pricing. Instead, The Trade Desk now taps into advertising platforms on both the demand-side and sell-side, which allow for real-time bidding, essentially giving advertisers a more efficient cost for what they are getting. While this service is not exclusive to The Trade Desk, it is crucial that it is adept in navigating this world, as any lack of capability here would undoubtedly be fatal.

On that note, the market in which The Trade Desk is operating is full of competitors. These include Alphabet (GOOG) (GOOGL) Ads, Display, and Video 360, Adobe (ADBE) Advertising Cloud, and Amazon (AMZN) Advertising. These are the most notable large-scale competitors, all of which offer real-time advertising markets. However, there are also younger companies, like Criteo (CRTO), Magnite (MGNI), PubMatic (PUBM), and Roku (ROKU), which also offer their own niche advertising market access related to automation and often connecting to Connected TV (‘CTV’) spaces. CTV is highly in demand at this time with advertisers, and The Trade Desk has wide integration with publishers and content providers related to CTV.

Peer Analysis

For the purposes of this analysis, I have decided to focus on the smaller companies rather than larger ones. Therefore, I have excluded Google, Adobe, and Amazon from the following table:

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The above table shows notable promise for The Trade Desk, but its compelling points come with a rich valuation attached. Its leading net income margin of 9.19% and third-highest five-year average revenue growth rate of 34.95% make me quite confident that I am getting both a fast-growing and provenly profitable enterprise if I invest. But notably, its balance sheet, while good against my chosen peers, still has room for improvement, in my opinion. However, it should be noted that most of these liabilities are accounts payable, and the company has no short-term or long-term debt at this time, which is incredibly promising. If it can reduce its accounts payable at a slightly faster pace, the balance sheet could become much more favorable, and then its common stock repurchases, which it has been increasing in recent years, would be much more welcomed by me as a potential investor.

However, of the companies listed in my table, I think Roku has some of the most direct competitive threats to The Trade Desk, particularly in the CTV field, due to its end-to-end control of the user platform and advertising space. However, the Trade Desk has been working with Roku, and to some degree, The Trade Desk’s business model offers much more diversified access to advertising, and I think its ecosystem is what really stands out and is viably the more long-lasting strategy of the two.

Valuation

The Trade Desk is selling at very high valuation multiples at the moment but slightly lower than its five-year average on many measures. I always try to put technology stocks that have traded at high valuation multiples for extended periods of time into proper perspective. When this is the case, there is no reason to believe this will drastically change any time soon. However, the caveat to this is the timeframe to measure this needs to be at least five years in my opinion. Any less than this, and I believe investors run the risk of being subject to misinterpreting short-term speculation as lasting market demand.

The Trade Desk is selling at a -32.58% difference to its five-year-average forward P/E non-GAAP, to be specific. It is also trading at a -21.49% difference from its five-year-average forward price/sales. With the growth rates that analysts expect over the next few years in both revenue and normalized EPS, I can’t help but think that the valuation at this time doesn’t look too unreasonable. I always believe when a company cannot be effectively valued through discounted cash flow or earnings, which is the case here, investors have to be extremely careful. It is often worth investing in these companies, but the element of speculation always remains. As such, a smaller allocation seems more prudent to me with The Trade Desk. While companies like Google and Amazon can justifiably be held without the security of a DCF margin of safety, newer companies like The Trade Desk do not have the same brand power and long-term generated goodwill, which means a little more caution is warranted, in my opinion. I think The Trade Desk is fairly valued at this time based on my valuation multiples analysis, but there is still valuation risk as it relates to changes in market sentiment, which may not correlate with actual financial results.

Advanced Technology Risk

Online advertising is clearly a very agile field, and as with advanced technology, innovations can happen fast and sometimes without warning. At the moment, The Trade Desk has a formidable position as a neutral platform for diverse digital marketing access, but there may come a time when its interface is not fully compatible with more advanced advertising algorithms that relate to more advanced machine learning, automation, and eventually, deep learning to fully automate advertising, creative, and publishing tasks. While this may seem some way off, as a long-term investor, I want to know that the company I am investing in has these concerns in mind. I believe The Trade Desk does, and it has made significant contributions to its platform by integrating bidding optimization and audience targeting, and deep learning for predictive analytics, but whether it has the capacity or the ability to be as deeply involved in automated advertising as Google could be, is doubtable. As such, The Trade Desk is fundamentally important right now, but as intelligent technologies become more advanced, I wonder how significant The Trade Desk will still be unless it fleshes out its intelligent technology divisions more thoroughly.

Conclusion

I truly admire this company, and having looked briefly into the management team, it looks well run and I commend it for creating a highly innovative platform. I think its diversification in access to a full spectrum of advertising partners makes it incredibly compelling. However, the risks I have mentioned related to technological change are very real, in my opinion, and I do not think the markets have fully recognized this at the moment. The change that could come over the next 10-20 years could be quite unprecedented, and as such, I think investors should look carefully at how companies are aggressively moving toward these changes rather than simply incorporating advanced features to mimic the status quo.