Shares of Toast (TOST -3.74%) have had an unbelievable year. As of this writing, they have skyrocketed 110% just in 2024 (as of Dec. 11). That gain outperforms the Nasdaq Composite index.
However, this growth stock still trades 41% below its peak, which might be compelling for investors looking to buy the dip. Before you do that, here are three things you need to know about Toast.
1. Its target market
Toast is a hardware and software company that caters specifically to the needs of the restaurant industry. For example, it offers point-of-sale devices to help accept payment methods. Its suite of services also includes marketing tools, employee management, omnichannel capabilities, loyalty programs, and loans. Investors can view the company’s offerings as being the operating system of a restaurant.
One obvious downside of serving restaurants is how sensitive that market is to macro forces. If there are recessionary fears and consumer confidence takes a hit, money spent by households on eating out is an easy thing to cut. Add this to a high failure rate in the industry, and it’s not exactly the best backdrop for a company like Toast.
In the three-month period that ended Sept. 30, the company generated $1.3 billion in revenue, of which 14% consisted of subscription services. Investors want to see this figure go up because it’s an extremely high-margin source of sales for the business.
2. Switching costs
In order to be a successful long-term investor, I think finding businesses that possess an economic moat is a key part of the equation. These high-quality companies have certain traits that allow them to defend their industry positions against existing rivals, as well as new entrants.
With that backdrop, I believe it’s clear that Toast is building an economic moat of its own. Software enterprises, particularly those that have become crucial to their customers’ daily lives, benefit from switching costs. This could also apply to the banking sector. Imagine if you had to change your credit cards, bank accounts, and brokerage to another financial institution. Think about the headache that would cause.
Toast is likely benefiting from its own switching costs. Management doesn’t provide data on churn, but it’s a good sign that the customer base keeps expanding. Moreover, some customers are using more and more services over time and as their needs evolve, a clear indication of how entrenched Toast is becoming.
Put yourself in the shoes of a restaurant owner or manager. Once a specific location’s employees are trained on Toast’s products and services, and those tools become fully integrated and work seamlessly, it’s difficult to change this setup. The risk is that you cause operational disruptions. As long as Toast continues to provide a fantastic user experience, it will keep existing customers happy and be able to bring on new ones.
Toast is also developing brand strength. Management points out that 75% of its customers come from inbound marketing channels, and a notable 20% come from referrals.
3. Growth potential
As an earlier-stage enterprise, Toast has exhibited noteworthy growth. Revenue in the third quarter was 168% higher than in the same period three years ago. Wall Street consensus estimates see the top line expanding 89% between 2023 and 2026, still a robust pace.
Key to the company’s strategy is to bring on more customers at a rapid clip. Toast currently has 127,000 different restaurant locations on its roster, after adding 7,000 in the last quarter. But management sees huge opportunities both in the U.S. and internationally.
Domestically, there are 875,000 restaurants in total. And outside the U.S., that figure balloons to about 14 million (excluding China). And restaurants are expected to spend $55 billion in the U.S. just on technology this year. That environment indicates that Toast still has lots of runway ahead of it.
If you are looking to buy the stock, now you know more about Toast’s customer value proposition, its switching costs, and the company’s growth potential.
Neil Patel and his clients have no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Toast. The Motley Fool has a disclosure policy.
