Shares of Toast (TOST -3.74%) have had an incredible year. At the time of writing, they are up 110% in 2024 alone (as of December 11). That profit exceeds Nasdaq Composite index.
However, this growth stock is still trading 41% below its peak, which could be attractive to investors looking to buy the dip. Before you do, here are three things you need to know about Toast.
1. Its target market
Toast is a hardware and software company that specifically addresses the needs of the restaurant industry. For example, it offers point-of-sale devices to help accept payment methods. The range of services also includes marketing tools, workforce management, omnichannel capabilities, loyalty programs and loans. Investors can think of the company’s offering as a restaurant’s operating system.
An obvious downside to serving restaurants is how sensitive that market is macro forces. When there are fears of a recession and consumer confidence takes a hit, it is easy to cut back on the money households spend on eating out. Add this to the industry’s high failure rate, and it’s not exactly the best backdrop for a company like Toast.
In the three-month period ending September 30, the company generated $1.3 billion in revenue, 14% of which came from subscription services. Investors want to see this figure rise as it is an extremely high-margin revenue source for the company.
2. Switching costs
To be a successful long-term investor, I think finding companies that have a… economic moat is an important part of the equation. These high-quality companies have certain characteristics that allow them to defend their positions in the industry against both existing rivals and new entrants.
Against that backdrop, I believe it is clear that Toast is building its own economic moat. Software companies, especially those that have become crucial to their customers’ daily lives, benefit from this switching costs. This could also apply to the banking sector. Imagine if you had to change your credit cards, bank accounts and brokerage services to a different financial institution. Think of the headache that would cause.
Toast likely benefits from its own switching costs. Management doesn’t provide churn data, but it’s a good sign that the customer base continues to grow. Additionally, some customers are using more and more services over time and as their needs evolve, this is 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 these tools are fully integrated and working seamlessly, it is difficult to change this setup. The risk is that you cause operational disruptions. As long as Toast continues to provide a great user experience, it will keep existing customers happy and attract new customers.
Toast also develops 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 early-stage company, Toast has demonstrated remarkable growth. Third quarter revenue was 168% higher than the same period three years ago. Wall Street consensus estimates expect revenue to grow 89% from 2023 to 2026, still a robust pace.
The key to the company’s strategy is to attract more customers at a rapid pace. Toast currently has 127,000 different restaurant locations in its database, after adding 7,000 in the last quarter. But management sees enormous opportunities, both in the US and internationally.
There are a total of 875,000 restaurants in the Netherlands. And outside the US, that figure rises to about 14 million (excluding China). And restaurants are expected to spend $55 billion this year on technology alone. That environment indicates that Toast still has many runways ahead of it.
If you want to buy the stock, now you know more about Toast’s customer value proposition, switching costs, and the company’s growth potential.
Neil Patel and his clients have no positions in the stocks mentioned. The Motley Fool holds and recommends positions in Toast. The Motley Fool has a disclosure policy.
