Shares of Toast (TOST -3.74%) have experienced a remarkable surge this year, soaring by 110% in 2024 alone (as of Dec. 11). This exceptional growth significantly outpaces the performance of the Nasdaq Composite index.
Despite this impressive growth, the stock still trades 41% below its all-time high. This presents a potentially enticing opportunity for investors looking to capitalize on a dip in share price. Before making any investment decisions, consider these three essential insights about Toast that could influence your strategy.
1. Target Market Insights: Catering to the Restaurant Industry
Toast is a comprehensive hardware and software provider that specifically addresses the unique challenges of the restaurant industry. The company offers a range of products, including point-of-sale systems designed to facilitate various payment methods, along with marketing solutions, employee management tools, omnichannel capabilities, loyalty programs, and financing options. Essentially, Toast serves as the operational backbone for restaurants, streamlining their processes and enhancing efficiency.
However, it’s important to recognize the inherent risks associated with operating in such a sensitive market. The restaurant sector is highly susceptible to macroeconomic factors. For instance, during economic downturns, consumer confidence often declines, leading to reduced discretionary spending on dining out. Coupled with a high failure rate among restaurants, this creates a challenging environment for Toast to navigate.
In the three-month period ending Sept. 30, Toast generated $1.3 billion in revenue, with 14% attributed to subscription services. This subscription revenue is particularly appealing to investors, as it represents a high-margin revenue source that has the potential for significant growth. Increasing this percentage will be a key focus for Toast as it aims to solidify its position in the market.
2. Understanding Switching Costs: Building Customer Loyalty
For investors aiming for long-term success, identifying businesses with a strong economic moat is crucial. Companies that create barriers to entry or have unique advantages are better positioned to fend off competition. Toast appears to be establishing its own economic moat by leveraging switching costs inherent in its software solutions.
In the software industry, especially for services that become integral to daily operations, switching costs can play a significant role. Consider the hassle and complexity involved in changing financial institutions; similar challenges apply to restaurant owners who would need to transition away from Toast’s systems. The difficulty of such a switch can discourage customers from leaving, fostering long-term loyalty.
Although management does not publicly disclose churn rates, the consistent growth in customer numbers suggests that Toast is successfully retaining its clients. Many customers are expanding their use of Toast’s services as their operational needs evolve, indicating a deepening reliance on the platform.
Imagine being a restaurant owner or manager; once your staff becomes proficient in using Toast’s solutions and those systems are fully integrated into your operations, the prospect of changing providers becomes daunting. The risk of operational disruptions looms large, making it essential for Toast to continue delivering an outstanding user experience to maintain customer satisfaction and attract new clients.
Additionally, Toast is strengthening its brand presence, with management noting that 75% of customer acquisitions come through inbound marketing channels, and 20% through referrals, underscoring the effectiveness of its brand strategy.
3. Exploring Growth Potential: Opportunities Ahead
Toast, as an emerging player in the market, has demonstrated significant growth, with third-quarter revenue reflecting a remarkable 168% increase compared to the same period three years ago. Analysts project continued expansion, with Wall Street estimating an 89% increase in revenue from 2023 to 2026, indicating a robust growth trajectory.
Central to Toast’s strategy is the rapid acquisition of new customers. Currently, the company serves 127,000 restaurant locations and added 7,000 new clients in the last quarter alone. Management sees substantial growth opportunities both domestically and internationally.
In the United States, there are approximately 875,000 restaurants, and globally, excluding China, the number swells to around 14 million. Notably, restaurants in the U.S. are projected to spend $55 billion on technology this year. This indicates a lucrative market for Toast, suggesting that the company still has significant growth potential ahead.
For those considering investing in Toast stock, this deeper understanding of the company’s customer value proposition, the importance of switching costs, and its extensive growth potential should provide valuable context for your investment decisions.
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.
