Move Over The Trade Desk, This Is Wall Street's New Favorite Adtech Stock

When advertising technology (adtech) company The Trade Desk (NASDAQ: TTD) went public in 2016, few people understood what the company did. Even today, relatively few people likely understand what it does. But for those who researched the business and purchased shares, they've been richly rewarded. The Trade Desk stock is up over 4,000% since going public, as of this writing.

The advertising industry is increasingly going digital. Video and audio content, for example, is being streamed more and more. And those things need a digital advertising solution.

Here's what the The Trade Desk does: It partners with advertisers, working within their budgets to get ads placed at various content publishers. Ads are placed through split-second auctions. And The Trade Desk targets the audience demographics that the advertiser is going after based on the data it has from the publisher.

This business model has paid off with incredible revenue growth. And investors haven't been able to get enough of The Trade Desk stock -- it frequently trades at a quite pricey valuation for this reason.

However, there's a new Wall Street darling stock in the adtech space. Whereas it took The Trade Desk about eight years to go from a market capitalization of about $1 billion to over $60 billion today, the market cap for AppLovin (NASDAQ: APP) is quickly skyrocketing toward $100 billion, leaving The Trade Desk in the dust.

TTD Market Cap data by YCharts

Here's why AppLovin is Wall Street's newest darling in the adtech space.

Why AppLovin stock is soaring

In August of 2022, it seemed like AppLovin's management was ready to throw in the towel. It proposed a merger with Unity with terms more favorable for Unity. Unity's shareholders would have the majority of the value, AppLovin co-founder and CEO Adam Foroughi would relinquish his role in deference to Unity's CEO, and Unity's board of directors would comprise the majority of the new board.

Unity turned down AppLovin's unsolicited proposal. And in the very next quarter, the third quarter of 2022, AppLovin reported a 2% year-over-year drop in revenue. For perspective, the company's revenue had been up 90% in the prior-year period. In short, it seemed like the wheels were coming off the business, as evidenced by its plunging growth rate. No wonder AppLovin's management wanted out.

At least, that's what it seemed like from a distance. But for those paying attention, something transformational was happening beneath the surface with AppLovin.

It turns out that AppLovin has two parts to its business. At the time, the bigger part was its mobile app business. The company had its own portfolio of mobile games. But according to management, this part of the business wasn't the ultimate goal. It was merely trying to gather as much first-party data as possible to build artificial intelligence (AI) algorithms for its software business.

In the same quarter that its revenue dropped 2%, AppLovin's software revenue was up a whopping 59% year over year and it's only gained ground from there. The company's customers are mobile app developers looking to monetize their apps. They turn to AppLovin, which uses its AI software to get the right ads placed in the right places.

In the second quarter of 2023, AppLovin launched an upgraded version of its software called Axon 2.0. Here's a look at AppLovin's software revenue growth since then.

Data source: AppLovin's financial filings. YOY = year over year.

To say that Axon 2.0 catalyzed AppLovin's growth would be an understatement. In short, mobile app companies using the new version of its software have seen massive improvements in their return on investment, motivating them to increase usage even more.

Furthermore, AppLovin's software did more than just catalyze its growth rate. The software business has great profit margins, which means that the company's profits are consequently soaring. Over the last 12 months, the company has $1.7 billion in free cash flow, which is around a 40% margin. Few businesses can match this.

This explains the impressive rise of AppLovin stock.

What's next for AppLovin stock?

While the past is important context, investors really want to know what's next for AppLovin stock. There is an encouraging closing thought here.

AppLovin's customers are primarily mobile gaming app developers. But considering how good its AI software is at monetizing these apps, management believes it's time to branch out. Right now it's piloting a launch into the e-commerce app sector. And early results are promising.

By branching out into new app sectors, AppLovin's management believes it can grow revenue at over 20% annually from here. If it can preserve its profit margins along the way, AppLovin stock could indeed have more upside.

Should you invest $1,000 in AppLovin right now?

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Jon Quast has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends AppLovin, The Trade Desk, and Unity Software. The Motley Fool has a disclosure policy.