Shares of Datadog (DDOG 4.60%) -- a data visibility company -- have hit all-time highs 18 times in 2021 alone, with the most recent occurrence on Nov. 5 when the company jumped 12%. This came after the company crushed its third-quarter earnings estimates, beating on both the top and bottom lines.
Shares have jumped 88% this year, reaching a market cap of $58 billion. After this massive run-up, some investors are wondering how much bigger this company can get. The answer? Much bigger. Despite the company being at all-time highs, here's why I think it is still worth adding to your portfolio.
Datadog operates a platform where companies can monitor all of their cloud operations and infrastructure, ensuring everything is secure and performing well. With an increasing amount of data coming from a company's expanding number of applications, it can be hard to monitor performance, security, and user experience all at once, but Datadog provides solutions for this. Datadog's dashboards allow companies to analyze data from their entire system on one dashboard, ensuring that security breaches will be caught, high-quality user experiences can be delivered, and applications will work optimally.
The company's financials back this idea up. Datadog has 1,800 customers spending over $100,000 on its platform, which grew 66% from the year-ago quarter. Its net revenue retention rate was over 130% in Q3 -- marking the 17th consecutive quarter it has been over 130%.77% of Datadog's customers are using two or more platforms, and 31% of customers are using more than three. Churn is in the mid-single digits, so Datadog's major growth opportunity is continuing to expand its relationships with its customers.
These strong customer relationships led to Q3 revenue growth of 75% to $270 million year over year, along with its net loss decreasing from $15 million to just $5.5 million -- or 2% of revenue. The company also generated $57 million in free cash flow in Q3, so its minor net loss is no problem at all. The company has been using its free cash flow diligently toward research and development, which represented $112 million in operating expenses in Q3 -- over 50% of total operating expenses.
The likely beneficiary of this high continued investment in research and development is Datadog's product offering. The company announced 10 new products and features at its annual user conference this quarter, including CI Visibility, which will help companies gain visibility into developer tests, and Session Replay, which will give companies insight into user experiences from a video-like interface.
Datadog provided strong guidance, which was increased from the original second-quarter guidance. Fourth-quarter revenue is expected to reach $291 million -- growing 8% quarter over quarter. The company upgraded its full-year guidance, with revenue guidance of $994 million -- up from Q2 guidance of $941 million.
Lowlights and risks
There wasn't much to complain about in this third quarter. Almost all metrics improved sequentially, and customer growth even accelerated. The only negative thing from this quarter was that the stock became even more expensive. The company traded at an (already high) valuation of 65 times sales on Nov. 3, but it jumped to 75 times sales today. When compared to Dynatrace (DT 3.38%) -- a Datadog competitor trading at 27 times sales -- it is clear just how expensive Datadog is today.
The valuation is the main risk for those looking to invest in Datadog, but when management consistently beats estimates and raises guidance like it did this quarter, a high valuation is not surprising. While there is plenty of competition in Datadog's space, Datadog is the leader, and with low churn and high net retention, it would be hard for a competitor to supplant Datadog in its role.
The road ahead
This quarter showed exemplary growth for Datadog, driven by a combination of factors that are bringing customers deeper into its ecosystem. The company noted that only 31% of its customers use four or more services, so while it has strong relationships with customers, there is still plenty of room to grow these relationships even more. As the company continues to do this, all while using its strong research and development budget to increase its offering, it can increase its retention rate while decreasing its churn rate. This would make it even harder for its competitors to catch up.
To monitor success, investors should watch for increases in customers paying over $100,000, net retention, and the number of customers using four or more services. All of this shows that Datadog is succeeding, meaning that the investment thesis is intact. This company is looking unstoppable, and it has avenues it can explore to continue its winning ways. Because of its strong success and evergreen future, you might want to consider adding Datadog to your portfolio before anything else.