Things just took another turn for the worse for Splunk (SPLK) stock. Already struggling as the company tries to manage its software platform's transition to the cloud, Doug Merritt -- the CEO since 2015 and who oversaw the company's growth from $450 million a year to nearly $3 billion today -- suddenly resigned in November. The stock price is now down nearly 35% in 2021 and has fallen all the way back to where it was in 2018 and 2019.

The recent executive leadership shake-up has pushed me to put my Splunk stock on the chopping block. It's been a profitable journey overall, as I've been a shareholder for years, but Splunk has fallen behind some of its peers in the data analytics and cloud observability space. Here's why I'm adding Elastic (ESTC -2.11%) stock to my holdings and buying more Dynatrace (DT -4.74%) to replace my Splunk holdings.

Someone holding a tablet. Illustrated charts are shown hovering above the screen.

Image source: Getty Images.

Where did this drama begin?

Splunk's "big data" software, which helps organizations sort and make sense of their operations and data, has been around since the early 2000s. As such, it predates the cloud computing era -- and as more companies make the switch to a more modern IT approach, Splunk has needed to follow suit and adjust the way it delivers its software, improve on its capabilities, and update the way it bills customers. It took a while for Splunk to finally make the jump, but this transition from legacy to cloud software is underway.

However, the transition has created a disconnect between the company's actual reported revenue and underlying cloud momentum. In Q3 fiscal 2022 (the three months ended Oct. 31, 2021), total revenue was up only 19% year over year to $665 million, even though cloud revenue was up 68% to $243 million. Basically, lots of customers are simply switching from old to new Splunk software, and with just over one-third of revenue cloud-based, this journey will still take some time to unfold.

Don't get me wrong, I think there's serious value in Splunk stock for investors that can patiently wait it out for a couple more years. But the departure of Merritt (which comes just months after Splunk accepted a $1 billion investment from private equity firm Silver Lake over the summer of 2021) is just one extra thread to this drama I'm not interested in following. Additionally, the initial outlook for next year's annualized recurring revenue (ARR, a combination of cloud and legacy revenue) implies 25% year-over-year growth -- not bad, but a slowdown from the recent pace of closer to 40% ARR growth. 

Thus I've decided to watch from the sidelines for now, even though Splunk could be a long-term bargain at just seven times trailing 12-month revenue. 

Two newer promising cloud observability stocks

In contrast to Splunk stock's dysfunctional behavior over the last few years, Elastic and Dynatrace have continued to grow -- both the businesses themselves and their share prices. Elastic is much further along in building its cloud-first software suite. And Dynatrace, after undergoing a total overhaul of its own under the purview of a private equity firm, is a cloud computing observability suite pure-play.

Because cloud software is a more significant portion of Elastic and Dynatrace revenue, both are growing much faster than Splunk (Elastic revenue was up 42% year over year in its last quarter, while Dynatrace grew 34%). Of course, neither company is perfect. Elastic isn't profitable yet, although that's mostly by design as it spends to promote growth. And Dynatrace's longtime CEO John Van Siclen just retired -- although Van Siclen will remain at Dynatrace in an advisory role until May 2022.

Elastic and Dynatrace's higher pace of growth and more focused attention on the cloud have also earned them a higher premium than Splunk stock. But I also view Elastic as something of a value considering its far higher pace of expansion, and Dynatrace is a leader in modern cloud infrastructure software for large enterprises.

SPLK PS Ratio Chart

Data by YCharts.

Investor takeaway

This is a tough decision for me. I tend to give my stocks ample room to run and allow plenty of time for them to fix issues. But Splunk still has a long way to go on this front, and its peers in data management and cloud observability (Datadog (DDOG -0.57%) is another one in this space I'm passing on for the time being) are quickly catching up to it. I plan on selling Splunk and reallocating to Elastic, and adding to my Dynatrace holdings before 2021 comes to a close.