Beyond its better-than-expected first-quarter results, Datadog (DDOG 0.50%) is poised to benefit from the secular shift to cloud computing. Yet because of the recent tech sell-off, the stock has dropped by more than 30% from its February all-time high. So should investors take this opportunity to consider buying Datadog stock?

Flawless execution

Thanks to its unified and easy-to-use observability platform that provides deep monitoring of modern cloud infrastructures and applications, Datadog has been generating strong revenue growth over the last several years, and the first quarter was no exception. 

Revenue increased by 51% year over year to $199 million, way above the guidance range of $185 million to $187 million. And given its confidence in the company's business, management raised its full-year revenue forecast to the range of $880 million to $890 million, which corresponds to impressive year-over-year growth of 47%.

Person using a futuristic head up display interface screen with data and key performance indicators for data monitoring and analytics.

Image source: Getty Images.

In particular, Datadog is firing on all cylinders with its land-and-expand strategy. The number of customers rapidly increased to 15,200 during the last quarter, up from 11,500 in the prior-year quarter. And with its consumption-based model, the company has been growing its top line as customers have been increasing their consumption of services.

Indeed, Datadog has been expanding its footprint beyond its core observability solutions to boost its business. For instance, it developed cybersecurity features last year. And following its acquisition of Sqreen in April, it will enhance its offerings for developers with extra application security capabilities.

Management showed strong execution with that strategy, as 25% of customers adopted four or more modules during the last quarter, up from 12% one year ago.

An opportunity?

Unsurprisingly, given Datadog's spectacular results, the stock doesn't seem cheap, even after having dropped by more than 30% from its February all-time high. It's trading at an elevated forward price-to-sales ratio of 27, which suggests the market expects the company to keep delivering phenomenal results over many years.

Granted, with its solid execution amid the secular shift to cloud computing, Datadog should keep generating strong growth for the foreseeable future. But that growth is likely to decelerate, as many players have been ramping up their efforts to develop competitive observability offerings. 

For instance, the legacy application monitoring vendor New Relic (NEWR) released its new unified observability platform New Relic One in August. It has been migrating its existing customers to that new platform to encourage the consumption of extra services, and it gave up its subscription-based business to adopt Datadog's usage-based model. During its earnings call last Thursday, the company confirmed its push in the observability area.

Also, the legacy log monitoring specialist Splunk (SPLK) revealed at the beginning of this month its new observability cloud platform. That announcement isn't surprising as the company has been expanding its core on-premises log monitoring capabilities to a more comprehensive cloud-based offering over the last few years. But this confirms the competitive landscape in Datadog's markets is becoming more and more crowded.

Large tech players have shown a strong interest in Datadog's markets as well. Following its acquisition of the application monitoring specialist AppDynamics in 2017, the networking giant Cisco Systems developed a complete observability platform. Also, at the end of last year, the database giant Oracle announced its new cloud observability and management solution, and in the scope of its transition to the cloud, IBM acquired the observability player Instana.

Thus, despite the recent tech sell-off that sent Datadog's stock much lower, I'd rather stay on the sidelines. The market is already pricing in strong future performance amid intensifying competition, which represents a risky investment that offers modest upside potential and limited downside protection.