Datadog (NASDAQ:DDOG) stock recently dipped after the data visualization company posted its fourth-quarter earnings. Revenue rose 56% year over year to $178 million, beating estimates by $14 million. Adjusted net income also surged 73% to $19 million, or $0.06 per share, which beat expectations by four cents.

The company expects its revenue to rise 41% to 43% in the first quarter and 37% to 38% for the full year. On the bottom line, management expects to eke out an adjusted profit of just $0.02 to $0.03 per share in the first quarter, while full-year earnings fall between $0.10 and $0.14 per share. That revenue guidance topped analysts' expectations, but the profit forecast for both periods came up short.

An IT professional checks a server in a data center.

Image source: Getty Images.

The lower earnings guidance was disappointing, but it wasn't surprising since Datadog recently made several acquisitions -- including the data pipeline firm Timber Technologies and the cloud-based security service provider Sqreen -- to expand its ecosystem. However, I believe investors should still consider buying Datadog's post-earnings dip, for five simple reasons.

1. A disruptive business model

Big companies often install their software and services across a wide range of computing platforms. Monitoring the performance of all those applications can be a tedious, time-consuming, and error-prone task for IT professionals.

Datadog simplifies that process by breaking down silos and pulling all of that data onto unified performance-monitoring dashboards. Over 400 software platforms, including Amazon Web Services and Microsoft Azure, provide native support for Datadog's services.

And demand for its services is rising. Datadog ended 2020 with 1,253 customers generating over $100,000 in ARR (annual recurring revenue), up 46% from 2019. The number of customers with over $1 million in ARR rose 94% to 50.

2. High net retention rates

Datadog has kept its net retention rate, which measures its year-over-year revenue growth per existing customer, over 130% for 14 consecutive quarters. It attributes that streak to its "land and expand" strategy, wherein it signs a customer up for a single service before cross-selling additional services.

At the end of the fourth quarter, 22% of Datadog's customers were using four or more of its products, up from 10% a year ago. More than 70% of its customers were using two or more products, up from about 60% a year ago.

3. Expanding margins

Many high-growth tech companies sacrifice their margins to grow their user base, revenue, and market share before focusing on profits. This isn't a major issue for Datadog: Its adjusted gross and operating margins either held steady or expanded in the fourth quarter and full year.

Period

Q4 2019

Q4 2020

FY 2019

FY 2020

Gross Margin*

78%

78%

76%

79%

Operating Margin*

7%

10%

(1%)

11%

*Non-GAAP figures. Data source: Datadog.

Datadog attributed the rising gross margin to its more efficient use of cloud hosting expenses and its higher operating margin to significantly lower sales and marketing expenses.

The company's near-term profitability could be pressured by its recent acquisitions, higher cloud spending, or more aggressive sales and marketing tactics. However, its resilience throughout the pandemic indicates that it still has plenty of pricing power in its niche market.

New Relic, which competes against Datadog in the application performance management (APM) market, recently posted year-over-year contractions in its adjusted gross and operating margins in the first nine months of 2020. Its net expansion rate, which is comparable to Datadog's net retention rate, also came in lower at 108% in its third quarter.

4. Rising cash flows

Datadog's soaring revenue and expanding margins, along with a convertible debt offering last June, boosted its free cash flow from just $791,000 in 2019 to $83.2 million in 2020. That massive jump explains why Datadog is buying up companies like Timber, which will improve its data observability features, and Sqreen, which blocks application-level attacks, to expand its ecosystem.

5. Cooling valuations

Last month, I claimed Datadog's stock could tread water for a few quarters, because its valuations were too hot. But I also noted it was a more compelling buy than other high-growth software stocks like Snowflake.

At $105 per share as of this writing, Datadog is worth $32 billion -- or 39 times this year's sales and over 800 times earnings. Those valuations are still sky high, but they've cooled down slightly in the stock's post-earnings decline, and it arguably remains more reasonably valued than Snowflake and other recent high-fliers.

The bottom line

Datadog stock is still pricey, and I don't recommend investors back up the truck at these levels. However, those who patiently build a position on these pullbacks could be well-rewarded over the long term as the company grows into its valuation.