Even during a down period for the markets, Toast has gone against the grain, climbing to $34.64. Its shares have yielded a 24.2% return over the last six months, beating the S&P 500 by 27.5%. This was partly due to its solid quarterly results, and the run-up might have investors contemplating their next move.
Is now still a good time to buy TOST? Or are investors being too optimistic? Find out in our full research report, it’s free.
Why Does Toast Spark Debate?
Founded by three MIT engineers at a local Cambridge bar, Toast (NYSE:TOST) provides integrated point-of-sale (POS) hardware, software, and payments solutions for restaurants.
Two Positive Attributes:
1. ARR Surges as Recurring Revenue Flows In
While reported revenue for a software company can include low-margin items like implementation fees, annual recurring revenue (ARR) is a sum of the next 12 months of contracted revenue purely from software subscriptions, or the high-margin, predictable revenue streams that make SaaS businesses so valuable.
Toast’s ARR punched in at $1.63 billion in Q4, and over the last four quarters, its year-on-year growth averaged 30.6%. This performance was fantastic and shows that customers are willing to take multi-year bets on the company’s technology. Its growth also makes Toast a more predictable business, a tailwind for its valuation as investors typically prefer businesses with recurring revenue. 
2. Projected Revenue Growth Is Remarkable
Forecasted revenues by Wall Street analysts signal a company’s potential. Predictions may not always be accurate, but accelerating growth typically boosts valuation multiples and stock prices while slowing growth does the opposite, though some deceleration is natural as businesses become larger.
Over the next 12 months, sell-side analysts expect Toast’s revenue to rise by 23%. While this projection is below its 42.8% annualized growth rate for the past three years, it is commendable and suggests the market is baking in success for its products and services.
One Reason to be Careful:
Low Gross Margin Reveals Weak Structural Profitability
For software companies like Toast, gross profit tells us how much money remains after paying for the base cost of products and services (typically servers, licenses, and certain personnel). These costs are usually low as a percentage of revenue, explaining why software is more lucrative than other sectors.
Toast’s gross margin is substantially worse than most software businesses, signaling it has relatively high infrastructure costs compared to asset-lite businesses like ServiceNow. As you can see below, it averaged a 24.1% gross margin over the last year. Said differently, Toast had to pay a chunky $75.93 to its service providers for every $100 in revenue. 
Final Judgment
Toast’s merits more than compensate for its flaws, and with its shares topping the market in recent months, the stock trades at 3.5× forward price-to-sales (or $34.64 per share). Is now the right time to buy? See for yourself in our comprehensive research report, it’s free.
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