Splunk, Datadog, and Elastic: 3 Ways to Invest in Data Analytics and Cloud Management

As the business world's migration to cloud-based operations has picked up steam in recent years, data analytics, log management, and application management software have been in high demand. The trend got a shot in the arm due to the COVID-19 pandemic, which compelled countless organizations to quickly deploy new cloud-based systems just to keep the wheels turning during shelter-in-place. 

As a result, shares of analytics software providers Splunk (SPLK), Datadog (DDOG 0.50%), and Elastic (ESTC 1.14%) are up 24%, 123%, and 38%, respectively, year to date. One can't make exact apples-to-apples comparisons between them: There is a little overlap between the services Datadog and Elastic provide, but both compete with elements of Splunk -- the largest industry player, offering services from simple data logging to cloud management to cybersecurity orchestration. With the cloud transition in full swing, I think investors could do far worse than to add any of these stocks to their portfolios. But one tops my list as the best buy right now.

Image source: Getty Images.

A view from above the clouds

The market has given these big data stocks significantly different valuations. Splunk -- the pure-play big data leader, and also the oldest in this group -- would appear to be stuck in neutral. That's not exactly the case, though. As I explained a few months back, Splunk has been migrating its business over to renewable cloud contracts, which creates some accounting changes that affect year-over-year revenue growth comparisons. But cloud-specific sales grew 81% and total annual recurring revenue (ARR) was up 52% to $1.78 billion in the first quarter of its fiscal 2021, which ended April 30, and it expects ARR to continue growing at an average mid-40% rate for the next couple of years.

Ultimately, Splunk's growth history is a testament to the opportunity that lies ahead, especially for Datadog, which is cloud-native and thus the fastest-growing business of these three -- it managed an 87% increase in revenue in its latest quarter. There's big potential for Elastic as well, which is undergoing a cloud transition of its own. 

Data source: Splunk, Datadog, Elastic, YCharts, and Noonum.ai.

Of note here is the stratospheric valuation placed on Datadog, which currently trades for 58 times revenue. Granted, it deserves a premium. Besides its growth, it has the highest gross profit margins of the three and is the only one with positive free cash flow over the last year.

However, it's worth mentioning Splunk returned to positive free cash flow in Q1 ($31.3 million) as it completed its transition to more modern billing. Elastic, though it is growing at an impressive rate, trades for far less than Datadog because of its smaller gross margins and negative free cash flow.

Also of note: Elastic had the least in cash and equivalents on its balance sheet as of last quarter. At the end of April, it had $297 million on the books -- which will easily cover its cash burn for quite some time -- and zero debt. However, Datadog had $795 million in cash and short-term securities and zero debt; and Splunk had $1.76 billion in cash and short-term securities and $1.74 billion in debt (in the form of notes that can be converted into stock).

To bolster their respective war chests, Splunk recently raised an additional $1.1 billion in cash and Datadog $634 million -- each via a fresh round of convertible debt issuance. Splunk said it will use $692 million of its proceeds to purchase and retire $488 million of its old convertible debt. At the end of the day, Datadog wins with the largest cash net of debt stockpile, but Splunk's liquidity is impressive -- although it gets discounted because its approximately $2.3 billion in notes (subsequent to the recent debt offering after the last quarterly report) could dilute current shareholders if redeemed for new shares in the coming years.   

Ranking my buy recommendations

To be clear, I think each of these cloud computing stocks is worth considering, and I think there's a good chance shareholders of Splunk, Datadog, and Elastic will be happy campers 10 years from now.

But I promised to reveal my preferred buy at the moment. As impressive as Datadog's momentum is -- not to mention its massive cash balance, which makes me think some acquisitions may be coming -- given its price-to-sales ratio of 58, I can't quite justify making a purchase at the moment.

Elastic is a little more appealing to me, with almost as impressive growth in the last year and a clean balance sheet. It is spending to promote growth, but that goes with the territory for a high-growth software firm. It too has competition, including a free-to-start version of its open-source software distributed through Amazon Web Services (AWS). But thus far, it seems that has done little to slow Elastic down.

Sitting atop my list is Splunk. Though the smaller upstarts are gunning for it, Splunk is quickly making the transition to cloud software and has finished migrating over to more modern billing. It's also profitable again (based on free cash flow). And longer-term, the industry leader still sees massive gains for data analytics and cloud management software. Though its price-to-sales discount relative to peers exists for a reason, I think Splunk will begin to rebuild its net cash stockpile, and it remains a formidable high-growth force to contend with in its industry. Right now, if I had to pick only one cloud management and data analytics stock to invest in, Splunk would be it.