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Is Datadog Stock a Buy?

By Herve Blandin - May 14, 2020 at 10:30AM

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The cloud-based monitoring specialist posted stellar first-quarter results.

Datadog (DDOG -0.11%) had first-quarter results that smashed expectations, and management raised its full-year guidance. But since the stock is at all-time highs after having more than recovered from the coronavirus-induced market sell-off in March, is it still a buy?

A high-growth profitable SaaS player

The software-as-a-service (SaaS) company should profit from the secular growth of cloud computing since it offers cloud monitoring capabilities.

Over the last several years, enterprises have been moving some of their infrastructure and applications to the cloud to have them accessible from anywhere. And recently, many employees were asked to work from home on short notice to try to limit the spread of COVID-19, which highlighted the benefits of cloud computing.

But even before the coronavirus-induced stay-at-home policies were enforced, Datadog was already growing at a fast clip. Last year, its revenue increased by 83.2% to $362.8 million.

And during the first quarter, that impressive growth accelerated to 87.4% as revenue jumped to $131.2 million, way above management's guidance range of $117 million to $119 million.

CEO Olivier Pomel said during the earnings call that the impact of the coronavirus on the company's results remained uncertain since Datadog is exposed to both troubled sectors (travel and hospitality) and stronger categories (streaming media, gaming).

In fact, the company's impressive performance is due to its frictionless products that customers can easily evaluate at a small scale as they move their applications and infrastructure to the cloud. As a result, the number of customers increased to 11,500 at the end of last quarter, up 40% year over year. 

These customers then expand their use of Datadog's solutions as they become persuaded about the value proposition. Also, Datadog offers multiple products to monitor different components of cloud infrastructures -- such as applications, networks, and more recently security --  which trigger cross-selling opportunities.

Thus, 63% of the company's customers were using two or more products at the end of last quarter, up from 32% last year. And for the 11th consecutive quarter, existing customers increased their spending by more than 30% compared with the year before.

In addition to that impressive revenue growth, Datadog posted a positive net income under generally accepted accounting principles (GAAP) for the second consecutive quarter thanks to its increasing scale.

And despite management's forecast of meaningful investments in data centers, research and development, and sales and marketing, it raised its full-year guidance and now expects positive adjusted earnings. In contrast, many high-growth SaaS players have been posting heavy losses due to their high sales and marketing expenses as a percentage of revenue.

Metric Previous Full-Year Guidance Range   Updated Full-Year Guidance Range
Revenue $535 million to $545 million $555 million to $565 million
Adjusted operating income (loss) ($20 million to $30 million) Up to $10 million
Adjusted net income per share ($0.03 to $0.07)  $0.02 to $0.06

Data source: Datadog. 

Person using a futuristic head up display interface screen with data and key performance indicators for data monitoring and analytics.

Image source: Getty Images.

Does the lofty valuation justify a buy?

With $798 million of cash, cash equivalents, restricted cash, marketable securities, and no debt, Datadog won't face any financial difficulty if a prolonged recession materializes. And given the company's stellar results, you can expect a high valuation. 

After some coronavirus-induced volatility over the last couple of months, the stock price has increased by more than 48% since its first trading day eight months ago. It has even more than doubled from its IPO price of $27.

DDOG Chart

DDOG data by YCharts.

Taking into account management's full-year guidance, the price-to-earnings ratio reaches 1,392. 

Granted, this lofty ratio is due to the slightly positive forecast on earnings per share. But even if you value the company based on the midpoint of its revenue forecast, the enterprise-value-to-sales ratio of 23.6 remains elevated.

With such valuation ratios, the market expects spectacular growth over the long term, which will become more and more challenging as Datadog's revenue base is increasing. As an illustration, even if management raised its full-year revenue guidance range, the midpoint corresponds to a decrease in the revenue growth rate to 54.4%, down from 83.2% the year before.

Thus, there's no doubt the company is delivering exceptional results in a cloud market that is poised to grow over the long term. But its rich valuation doesn't leave much margin of safety, and prudent investors should stay on the sidelines.

Herve Blandin has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Datadog. The Motley Fool has a disclosure policy.

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