The adoption of cloud computing should remain strong as the technology simplifies remote access to applications and allows on-demand scaling of computing resources. Tech outfits Datadog (NASDAQ:DDOG), Zoom Video Communications (NASDAQ:ZM), and Snowflake (NYSE:SNOW) have been taking advantage of that secular trend thanks to their innovative products and services. But the market may have become too optimistic as it is valuing these players for flawless execution over the long term.
Enterprises must monitor the infrastructures and applications they have been moving to the cloud. Datadog was founded in 2010 to address that need while legacy players were slow to adapt their on-premises solutions.
Thanks to its easy-to-use products and expanding monitoring capabilities, the company has been generating strong results.
During the most recent quarter, revenue increased by 68% to $140 million. And full-year revenue is expected to grow 57% based on the midpoint of the company's guidance range. What's more, as Datadog is scaling, it is becoming profitable. Management anticipates turning last year's adjusted operating losses of $5.4 million into operating income in the range of $28 million to $34 million this year.
Given those spectacular results, Datadog's share price has jumped more than 180% since the beginning of the year, valuing the stock at 57 times the midpoint of the forecast for full-year revenue.
Granted, the company is poised to keep growing as the consumption of cloud-based solutions increases. In addition, it announced this week a strategic partnership with Microsoft, which should fuel its growth beyond the short term. But the competition will be intensifying as many monitoring specialists, including Splunk, Sumo Logic, and Elastic, have been enhancing their offerings with similar cloud-based monitoring and analytics capabilities.
Datadog's lofty valuation indicates the market assumes competition won't make a dent in the company's performance, which looks like an overly optimistic scenario.
2. Zoom Video Communications
As shelter-in-place orders boosted the use of remote communication products, Zoom's performance dwarfed Datadog's over the past couple of quarters.
In the second quarter, revenue grew 355% to $663.5 million, and management significantly raised its full-year revenue guidance to between $2.37 billion and $2.39 billion, up from a range of $905 million to $915 million at the beginning of the year.
In addition, free cash flow jumped to $373.4 million in the quarter, up from $17.1 million in the year-ago period, representing an outstanding free cash flow margin of 56%. However, since Zoom collects cash from customers in advance of providing services, that free cash flow margin was boosted by the coronavirus-induced surge in consumption of Zoom's products, which isn't sustainable.
Given its phenomenal results, the company's stock price has jumped more than 600% since the beginning of the year, driving its market cap above $138 billion. In comparison, management last year estimated the company's total addressable market at $43 billion by 2022.
Zoom's valuation at 58 times its full-year revenue forecast suggests investors anticipate the company will dominate its market by a wide margin. Yet competitors aren't standing still. Microsoft, for instance, has been improving its Microsoft Teams platform to chase the attractive opportunity.
The coronavirus-induced surge in remote communications certainly increased Zoom's addressable market, but even if Zoom sustains impressive growth over the next many years, its stock price upside potential remains limited.
Zoom's valuation pales in comparison to Snowflake's price-to-sales (P/S) ratio, which reached 115, based on analysts' full-year revenue estimates of $575.5 million.
Berkshire Hathaway's investment in Snowflake probably boosted investors' confidence, but, more importantly, Snowflake generated phenomenal revenue growth of 121% to $133 million during the last quarter. And it is poised to keep growing as it offers an innovative cloud solution that facilitates the management and analysis of enterprises' growing volume of data. Management estimates the company's total addressable market at $81 billion.
Investing in Snowflake remains risky, though.
The company is generating significant losses as it invests in its growth. Last quarter, sales and marketing expenses represented 70% of revenue, which led to a loss of $77.6 million, compared to $93.4 million one year ago.
Also, Snowflake remains in a delicate position with public cloud vendors: It competes with their big data solutions and relies on their computing infrastructures to deal with its customers' data. In addition, competition is intensifying as legacy on-premises players such as Cloudera have been developing cloud big data offerings.
The company's lofty valuation suggests the market expects nothing less than an astonishing performance over the next several years, which is a risky proposition for investors.