Datadog's (NASDAQ:DDOG) stock surged about 160% over the past 12 months as the data monitoring company impressed investors with its robust revenue growth. But with a market cap of $31.7 billion, this high-flying stock now trades at 40 times next year's sales. Can Datadog justify that premium valuation throughout 2021 and head even higher?

A disruptive silo-buster

Large companies often store their data across a wide range of computing platforms, including servers, databases, cloud services, and mobile apps. Monitoring all that data can be tedious for developers and IT teams, so Datadog's platform breaks down the silos and pulls all the information onto unified dashboards.

Three IT professionals work in front of a computer.

Image source: Getty Images.

Over 400 platforms, including Microsoft's Azure and Amazon Web Services (AWS), can be integrated into Datadog's platform. Over the past year, Datadog expanded that platform with new features, including new security services, mobile app monitoring tools, and its Datadog Marketplace for third-party integrated apps.

It ended last quarter with 1,107 large customers, which were generating more than $100,000 in annual recurring revenue (ARR), up from 727 a year earlier. Like many other software companies, Datadog deploys a "land and expand" model, in which it locks in a customer with a single product to cross-sell additional services.

Over 70% of its customers were using two or more of its products last quarter. About 20% were using four or more products, up from just 7% a year ago. It also maintained a net retention rate of more than 130% over the past few quarters, which means its existing customers are paying 30% more year-over-year for its services.

Why did Datadog dazzle the bulls?

Datadog's revenue rose 83% to $362.8 million in fiscal 2019. Its GAAP net loss widened from $10.8 million to $16.7 million, but narrowed on a non-GAAP basis from $5.0 million to $1.9 million.

In the first nine months of 2020, Datadog's revenue rose another 71% year-over-year to $425.9 million. Its GAAP net loss narrowed from $17.6 million to $8.4 million, and it generated a non-GAAP net profit of $52.5 million, up from a loss of $11.5 million a year earlier.

Datadog expects its revenue to rise 62%-63% for the full year, and to remain profitable on a non-GAAP basis. Next year, analysts expect its revenue to rise 36%, and for its non-GAAP earnings to grow 6%.

Why Datadog's stock could attract the bears

Datadog's core business looks healthy, but its decelerating revenue growth makes it difficult to justify its frothy price-to-sales ratio. There are plenty of other software companies generating comparable revenue growth but trading at lower valuations.

JFrog (NASDAQ:FROG), which also breaks down silos with its universal repository for software updates, is expected to generate 31% revenue growth next year, but trades at less than 30 times that forecast. Zoom (NASDAQ:ZM), the video conferencing darling that became a household name during the pandemic, is expected to generate 38% revenue growth next year -- but trades at less than 30 times next year's sales.

Datadog also faces competition from similar data monitor companies like Splunk, New Relic, and Elastic. Diversified tech giants like Cisco and IBM can also bundle similar dashboards with their software services.

The fragmentation of this market could throttle Datadog's long-term growth, even if it widens its moat via streamlined integrations with cloud giants like AWS and Azure. On the bright side, Datadog's expanding gross margins indicate it still has plenty of pricing power in this high-growth market.

Datadog's stock could tread water in 2021

Datadog is a promising growth stock, but I doubt it can replicate its gains from 2020 this year. The stock is priced for perfection at these levels, and the company will need to crush -- not just beat -- Wall Street's estimates to keep advancing.

I don't expect Datadog's stock to decline significantly this year, since its core business still looks strong. However, I expect its stock to tread water as the business catches up to the stock and its red-hot valuations.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.