In the current stock market environment, where even minor deviations from Wall Street’s expectations can lead to significant stock price reactions, Toast, the restaurant Point of Sale (PoS) platform, recently faced a nearly 20% drop in its stock price. This decline followed the release of its Q3 earnings report, which, to the surprise of many, exceeded expectations on the profitability front. However, the company also made adjustments to its revenue outlook for the year, leading to the pronounced stock drop. But is this reaction justified, or does it present a compelling opportunity for investors to consider Toast as a long-term investment?
Understanding the Context
Before diving into the investment potential of Toast, let’s first consider the broader context of the stock market. We’re currently witnessing a Q3 earnings season characterized by volatility, driven by concerns about lower interest rates. Companies that fall even slightly short of Wall Street’s expectations are being penalized with significant downward stock price reactions, even when the underlying news is relatively positive.
Evaluating Toast’s Performance
Toast’s recent stock price drop occurred despite Q3 results that outperformed expectations, particularly in terms of profitability. The company also made slight adjustments to its revenue guidance for the remainder of FY23. It’s crucial to assess whether these changes justify such a significant decline in stock value.
The adjusted revenue outlook now stands at $3.83-$3.86 billion, representing 40-41% year-over-year revenue growth. This adjustment implies a revenue plan of $1.00-$1.03 billion for Q4, which, while slightly below consensus estimates, still represents substantial growth. The question that arises is whether a minor 3-5 points deceleration in top-line growth for Q4 warrants a nearly 20% stock price drop. Additionally, there is a leadership change, with CEO Chris Comparato stepping down and former COO Aman Narang taking the helm. However, this transition is expected to be smooth and not disruptive to the business.
The Investment Opportunity
Despite the recent turbulence in Toast’s stock price, there are compelling reasons to consider this as a long-term investment opportunity:

Dramatic Expansion Potential: Toast is more than just a specialized PoS system for restaurants; it aspires to be the software management platform of choice for the entire restaurant industry. This positions it favorably against more generalized competitors like Square. The company estimates its Total Addressable Market (TAM) at $110 billion, indicating less than 1% current penetration.

Cross-Selling Momentum: Over 40% of Toast customers are now using six or more Toast products, reflecting the deepening cross-selling momentum. This is a significant improvement from a few years ago.

Holistic Platform: Toast’s software solutions cater to various service models, including takeout orders and corporate catering events, not just dine-in services.

Approaching Profitability: With a greater revenue mix into software and growing economies of scale, Toast is approaching adjusted profitability for the first time.

Furthermore, Toast is currently installed in only 10% of U.S. restaurants, indicating substantial room for domestic expansion. As it continues to broaden its offerings and serves a variety of customer types, there is immense potential for growth. The recent stock price drop might be an opportunity for investors to take advantage of market dislocation and establish a long-term position in Toast.
Analyzing Q3 Results
Taking a closer look at Toast’s Q3 results, the company’s revenue grew 37% year-over-year to $1.03 billion, in line with Wall Street’s expectations. While this represents a deceleration compared to the previous quarter, it is still a healthy growth rate. The company is also expanding its reach, with growth in the number of locations where Toast is installed.
From a product perspective, Toast launched a specialized offering called “Toast for Cafes & Bakeries” within the quarter, further expanding its software offerings. Additionally, significant upgrades were made to the mobile app for restaurant operators.
The company’s Annual Recurring Revenue (ARR) grew by 40% year-over-year to $1.22 billion, adding approximately $80 million of net-new ARR in the quarter. This demonstrates strong growth in the subscription-based revenue model.
From a profitability standpoint, Toast achieved a record adjusted EBITDA margin of 3.4% in the quarter, with sequential and year-over-year improvements. This was driven by operational expense growth rates that lagged behind revenue growth.
Conclusion: A Long-Term Investment Opportunity
In conclusion, the recent post-earnings drop in Toast’s stock price appears to be an overreaction to a business that continues to grow at a healthy pace and achieve substantial margin expansion. With its low penetration in the U.S. and worldwide, Toast has ample room for expansion. Its reputation as a restaurant-focused POS platform sets it apart from rivals like Square.
Therefore, for investors with a long-term perspective, this dip in Toast’s stock price could be an opportunity to consider a promising investment in a company with significant potential in the restaurant technology sector. Despite the recent market turbulence, staying invested in Toast and buying the dip might be a strategic move for those looking to capitalize on the company’s growth prospects.