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The Worst Mistake DigitalOcean Investors Can Make Right Now

By Jamie Louko – Dec 21, 2021 at 6:40AM

Key Points

  • Shares have fallen a lot, but this sell-off is not because the business is doing anything wrong.
  • DigitalOcean has been executing on all business fronts and distinguishing itself from competitors.
  • Investors should consider simply holding their shares instead of selling out right now.

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With the business performing flawlessly, the last thing investors should be doing is selling out.

Shares of DigitalOcean (DOCN 0.50%) have performed amazingly well in 2021, but recently, they have started to slide. Over the past month, shares are down over 40%, primarily because the tech sector at large has been getting crushed over the past few months.

Share price performance, however, has not been indicative of business performance. As a matter of fact, DigitalOcean has been executing extremely well. While the share price drop might be concerning for many investors, dumping shares solely because the stock price is down could be a costly mistake.

Person looking at a clear whiteboard, thinking.

Image source: Getty Images

DigitalOcean is executing

In an internal study, DigitalOcean found that 13% of small and medium-sized businesses (SMBs) say that technical training and cloud education is a barrier to cloud adoption, and cloud offerings like Amazon Web Services (AWS) have not helped solve this problem. Solutions like AWS are very technical and complex because they are built for professionals, but SMBs and independent developers are often newer to the cloud and uncomfortable using these solutions. 

DigitalOcean provides a cloud offering specifically for SMBs built on simplicity, transparency, and a community of expert developers available to help SMBs. The company provides basic offerings like "droplets" -- small, easy to run servers that can be spun up in seconds -- as well as app development tools. Its pricing models are transparent and clear, and the company gives access to tutorials and explanatory videos from a wide variety of cloud experts to help its customers learn. 

Even though AWS and other competitors have offerings specifically made for SMBs, they fail to provide these critical aspects. Therefore, DigitalOcean has emerged as the main cloud provider for small businesses. The company has almost 600,000 customers across the world, which has resulted in achieving accelerating quarterly top-line growth and trailing-12-month revenue of $396.4 million.

DigitalOcean has also done a stellar job increasing its relationships with customers by bringing them deeper into the product ecosystem. SMBs are notorious for having higher churn than enterprises because of their smaller budgets, but DigitalOcean has done a great job retaining customers. The company lost just 4,000 customers from Q2 to Q3 of 2021, but while that sounds like a lot, it represents less than 1% of its total customer count. With this low churn, the company has also been able to increase customer spending. Its net retention rate is 116%, meaning that including churning customers who now spend nothing, customers from Q3 2020 are now spending 16% more. This shows investors that DigitalOcean has been able to retain customers and bring them deeper into the ecosystem, a difficult thing to do in the SMB market.

Why selling out could be costly

Despite shares being down over the past month, it is important to zoom out. Since coming public in early 2021, the stock is up 71%. Therefore, you might be losing money on paper today, but you are likely green on your investment. In a volatile market, it is always important to zoom out and look at the larger trend, and DigitalOcean is no exception.

Even though the company is up a lot, there is still astounding growth ahead. DigitalOcean estimates that there are 100 million SMBs globally and a projected 14 million more SMBs will be born annually. With this, DigitalOcean's addressable market is expected to nearly triple to $116 billion by 2024. With less than $400 million in trailing-12-month revenue, DigitalOcean's opportunity to grow is vast.

As if the story couldn't get any better, the company is profitable. Most companies that grow 35% year over year with massive addressable markets ahead of them are bleeding cash, but DigitalOcean has been able to obtain a net income margin of 2.4% so far this year. This balance that the company has made between investing in research and development while bringing cash to the bottom line shows management's allocation expertise -- something that will undoubtedly serve the company well over the next decade.

The right move

While it might be tough to ride this downturn for the next week, month, or maybe even year, your future self will thank you. Volatility in your portfolio can be hard to bear, but that is the price of admission into the stock market. 

DigitalOcean has built a platform that some of the best businesses in the world have failed to achieve, and this had resulted in it becoming a primary cloud provider for SMBs. With this title and impressive brand loyalty from a notoriously brand-agnostic consumer base, the company has the potential to become a behemoth in the SMB market. While it might be difficult to hold shares now, I think that riding through this volatility will pay off immensely in the future. 

For more aggressive investors, now might even be a time to add to your position. The company trades at 17 times sales, which is not all that expensive for tech stocks. Another company that focuses on SMBs, Shopify, trades at a whopping 38 times sales. Meanwhile, DigitalOcean's valuation has fallen from 30 times sales earlier this year to about 16 today. I believe that this drop and the positive financial backdrop make for an appealing opportunity to add shares of this innovative company to most any portfolio.

John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Jamie Louko owns Amazon and Shopify. The Motley Fool owns and recommends Amazon, Digitalocean Holdings, Inc., and Shopify. The Motley Fool recommends the following options: long January 2022 $1,920 calls on Amazon, long January 2023 $1,140 calls on Shopify, short January 2022 $1,940 calls on Amazon, and short January 2023 $1,160 calls on Shopify. The Motley Fool has a disclosure policy.

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