Should You Buy This Supercharged Growth Stock That's Down 39% Right Now?

The stock market's impressive run over the past couple of years has lifted some businesses much more than others. For example, shares of one software-as-a-service (SaaS) company have surged 111% higher just in the past 12 months.

That's not surprising, given the impressive trajectory this business is on. Yet even after that run, its shares still trade 39% below the peak they touched in November 2021. Is this still a good time to buy this supercharged growth stock?

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Taking care of the restaurant industry

Toast (NYSE: TOST) has made a name for itself by catering specifically to the needs of the restaurant sector. With a comprehensive product and service assortment that ranges from point-of-sales devices and payroll management to marketing tools and working capital loans, it's a one-stop shop for the tools that managers and owners need to better run their operations.

Since its founding in 2012, Toast has registered fantastic growth. Even amid macro headwinds, its top-line gains have been notable, and they still continue. In the third quarter, Toast posted 26% year-over-year revenue growth. It also added 7,000 new restaurant locations to its customer base, bringing the total to 127,000.

Yet the company still has a sizable runway. There are 875,000 restaurant locations just in the U.S., and 15 million internationally (excluding China). Toast's comprehensive product suite won't find its way into all of them, but it has huge room for expansion.

Becoming financially sound

After years of posting losses, Toast is starting to report earnings. In the second and third quarters of last year, it produced combined net income of $70 million.

Toast's leadership team might now have the experience to be able to better leverage its operating expenses. Spending money on sales, marketing, and research & development is certainly necessary for the future of this company. But these costs won't need to grow as much as they have historically now that Toast has a well-established industry presence.

The company also will benefit from switching costs, a key competitive advantage. As a growing number of customers commit to its ecosystem for the long term rather than putting resources into changing service providers, Toast won't have to spend as much on marketing to acquire new clients. And because customer satisfaction is high, those established clients have even less incentive to stray.

I think we're already witnessing the benefits of Toast's ability to provide its restaurant clients with lots of value. Given that 20% of new customers come from referrals and 75% from in-bound channels, the service is already attracting significant interest.

Is valuation important to you?

A year ago, before Toast's stock more than doubled, it traded at a price-to-sales (P/S) ratio of 2.6. That looked like a compelling entry point. Today, after more than doubling in price, the stock trades at a P/S multiple of 4.8, which I think might be too steep of a valuation.

But now that Toast is generating positive net income, investors can also weigh it on earnings-based valuation metrics. Shares now trade at a forward price-to-earnings ratio of about 44. At first glance, that doesn't scream bargain, either.

According to analysts' consensus estimates, Toast's earnings per share are projected to grow by 102% between 2024 and 2026. It's best to take such forecasts with a grain of salt, but they do offer a reasonable idea about what could happen. If you believe earnings are going to skyrocket, the current valuation doesn't look expensive. Investors who buy in today are pricing in that bright potential future. Whether it will appear is, of course, uncertain.

Investors who are bullish on Toast should consider opening a small position at first, and -- if earnings trends justify it -- purchase more shares over time.

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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.