Tech companies are facing a tough time as the digitalization trend that surged during the pandemic returns to normal levels. Pair that with worsening macroeconomic conditions, and top tech companies like Amazon, Alphabet, and Meta have announced massive layoffs as the environment becomes increasingly challenging.
Datadog (DDOG -3.94%), the monitoring and security platform for cloud applications, went against the crowd by delivering mind-blowing growth of 61% in the third quarter of 2022. Upon further inspection, there are even more reasons to like the stock.
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Datadog's strong track record of execution
Datadog is a software-as-a-service (SAAS) company that helps customers monitor and secure their cloud applications and IT infrastructure. With Datadog's products, companies reduce the risk of downtime, secure their IT systems, and ensure the best user experience for their customers.
Initially offering a real-time software application and infrastructure monitoring service, Datadog has added multiple new products over the years, covering areas like application-performance management, log management, and more recently, cloud security.
By giving customers a simple-to-implement and easy-to-use platform, Datadog helps customers manage ever-more complex IT environments thanks to the growth of cloud computing. In return, satisfied customers spend more money with the company, while new customers continue to join the platform.
As a result, revenue surged tenfold from $101 million in 2017 to $1.03 billion in 2021. Management's latest guidance calls for 2022 revenue to hit $1.65 billion. On top of that, free cash flow has been positive in the last three years. It's quite impressive for a hypergrowth company to deliver this kind of growth with solid cash flow as well.
The future looks bright for the company ...
While past performance is no guarantee of future results, there are good reasons for investors to be optimistic going forward.
Topping the list is the massive tailwind of digital transformation and cloud migration that will remain in effect for the next decade (or potentially decades). In 2021, global cloud spending was just 8% of total global IT spending, indicating lots more growth is coming for the cloud-computing industry.
For its part, Datadog estimated that its target addressable market (TAM) will grow from $41 billion in 2022 to $62 billion in 2026. With just $1.53 billion in trailing-12-month (TTM) revenue, the young company has just touched the tip of the iceberg.
To capture this vast opportunity, Datadog invests heavily in marketing (24% of TTM revenue) and research and development (30% of TTM revenue). The former attracts new customers, while the latter fuels new products and services to increase existing customer-wallet share.
And here's the good news. Datadog has demonstrated this spending is paying off. In the last five years, the customer count more than tripled from 5,403 in 2017 to 18,800 in 2021. The percentage of customers using more than two products has also improved over time, up from 71% in the third quarter of 2020 to 80% in the third quarter of 2022. The change becomes even more stark for customers using four or more productions with that percentage doubling to 40% over the same period.
So long as Datadog can continue to innovate and deliver more (and better) products over time, it should have no problem keeping its growth machine spinning for years to come.
... but I'm not buying yet
Datadog has plenty of ingredients to make it a successful business, but that doesn't necessarily guarantee that it will be a winning investment for two reasons.
First, it has yet to prove itself in an economic recession. Thus, I would like to see how the company performs in the downturn many people are expecting this year. Datadog has defied the naysayers so far with its continued growth in 2022, and it will be important to watch the company's progress in the event the economy weakens further.
Second, the stock trades at a premium. For perspective, the tech company has a price-to-sales (PS) ratio of 15.7, which is higher than the valuation for established tech companies and even other high-growth names in the sector.
While it's not unreasonable for Datadog to trade at a premium given its rapid growth and strong prospects, buying at today's price offers no margin of safety. That said, I'm adding the stock to my watchlist and waiting for a better entry point.
