Shares of data search and analytics firm Elastic (NYSE:ESTC) had a stellar 2020, soaring 127%. And the stock's momentum has extended into 2021 -- it's up another 15% year to date as of this writing. Even after that incredible run, though, Elastic still might be a buy as it strikes a balance between enviable growth and a reasonable valuation compared to some of its highest-flying peers.  

Data search and observability is a modern staple

Elastic has built itself into a top destination in the data and analytics space with its open-source Elasticsearch software. In fact, Elasticsearch has free-to-use basic functionality on Amazon's (NASDAQ:AMZN) AWS cloud computing platform, and paid premium enterprise search and cloud operations observability features are available as Amazon Elasticsearch Service.

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Image source: Getty Images.

In spite of its free software tier -- and a big, worrisome competitor in AWS -- Elastic has expanded rapidly. Its paid services have become must-haves for many companies as they help organizations develop a wide range of applications from data and document search to cloud security -- all available via a single software platform. And after growing revenue 57% in its fiscal 2020 (which ended April 30), the software firm got off to another great start through the first half of its fiscal 2021.  

Metric

6 Months Ended Oct. 31, 2020

6 Months Ended Oct. 31, 2019

 Change

Total revenue

$273.8 million

$190.8 million

43.5%

Gross profit margin

73.2%

71.2%

2.0 pp

Free cash flow (including acquisition costs)

$3.05 million

($29.0 million)

N/A

Data source: Elastic. PP = percentage points.  

As Elastic expands, its profit margins keep improving. The company also recently turned free cash flow positive -- although growth is the priority right now rather than maximizing the bottom line. Nevertheless, that was a notable milestone for this software outfit as it means it's no longer using cash from its balance sheet to cover its heavy marketing and research expenses.

A not-so-unreasonable price tag

Elastic stock could have some serious legs. Within its software subscription model for data management, cloud-based software-as-a-service (SaaS) subscriptions are in high demand right now given the digital transformations many organizations are trying to achieve amid the pandemic. SaaS revenue increased 81% year over year during the fiscal 2021 second quarter to $37.4 million. And since business overall is still growing, Elastic isn't suffering from the accounting effects that can come with migrating to a cloud-based model -- a problem that cropped up for its data analytics peer Splunk in the last year as it switches its customers over from its legacy software subscriptions to cloud subscriptions.

Granted, many investors might be uncomfortable with investing in Elastic since it intentionally operates at breakeven. The heavy rate of spending on sales, marketing, and development of new platform features isn't likely to ease anytime soon as long as the cloud computing market continues to expand. Various estimates expect global cloud computing spending to double within the next decade. Given this situation and Elastic's fast pace of expansion and improving profit margins, shares look like a relative value at 30 times trailing 12-month sales.

By comparison, Splunk trades for only 12 times trailing revenue, but it has yet to start reporting year-over-year growth as it continues to manage its transformation to a cloud-first company. Datadog trades for 59 times sales, though, a far higher premium. However, its top line grew at a faster 61% year-over-year pace in its last reported quarter. Of these three names, Datadog also has the most net cash and short-term investments on its books ($927 million after subtracting debt as of Sept. 30), but Elastic has a respectable war chest too with $349 million and no debt.

Simply put, Elastic strikes an enviable balance between strong growth, an operation that's now self-funding (since free cash flow is no longer negative), and shares that are trading at a relative value. As the ability to make use of data in the cloud is only going to increase in importance for businesses, Elastic is a solid buy in my book.