Software companies are some of the fastest-growing stocks in the tech sector for three simple reasons: Software is easier to distribute than hardware, it locks in customers with sticky subscriptions, and it's on the front line of secular growth trends like artificial intelligence (AI), analytics, and automation.
However, software stocks can also be expensive, volatile, difficult to understand, and highly exposed to inflation and interest rate headwinds. So today, I'll highlight three high-growth software stocks that are still worth buying even as many investors rotate toward safer blue-chip stalwarts.
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1. Palantir
Palantir (PLTR -1.41%) provides data mining and analytics services for large government and enterprise clients. Its Gotham platform mainly serves U.S. government agencies, while its Foundry platform leverages that technology to help large companies streamline their operations and make data-driven decisions.
Palantir's revenue rose 25% in 2019 and grew 47% in 2020. It expects its revenue to increase 40% in 2021 and grow at least 30% annually from 2021 to 2025. That bullish long-term forecast implies its annual revenue will more than triple from $1.53 billion in 2021 to over $4 billion by 2025.
Palantir isn't profitable on a generally accepted accounting principles (GAAP) basis yet, but its adjusted gross and operating margins have been steadily expanding as its free cash flow (FCF) turned positive in 2021. Analysts expect it to remain unprofitable for at least the next two years.
Palantir's stock trades at 17 times next year's sales. It certainly isn't a value stock yet, but it has a reasonable valuation compared to other high-growth tech stocks. Cloudflare, for example, is only growing slightly faster than Palantir but trades at over 50 times next year's sales.
If you believe Palantir can achieve its goal of becoming the "default operating system for data across the U.S. government" while leveraging that hardened reputation to gain more enterprise customers, then it might be a great time to accumulate more shares of this high-growth stock.
2. Zendesk
Zendesk (ZEN) provides cloud-based customer relationship management (CRM) tools to approximately 111,800 customers worldwide.
Unlike Salesforce (CRM -2.04%), which provides a full suite of CRM tools for large enterprises, Zendesk provides simpler chat-based customer support and ticketing services catered for use by smaller companies. Growing companies can also integrate Zendesk's services into Salesforce's platform.
Zendesk's revenue grew 26% in fiscal 2020, and it expects 29%-30% growth this year. It ended last quarter with a dollar-based net expansion rate of 122%, which exceeded its own long-term target of 110%-120%.
Zendesk isn't profitable on a GAAP basis yet, but its adjusted gross margins have been expanding. Its non-GAAP earnings also grew 68% in 2020, and analysts anticipate another 25% earnings growth this year.
Zendesk's stock stumbled over the past three months as investors fretted over its planned acquisition of Momentive (MNTV), which owns Survey Monkey. That all-stock takeover will likely dilute Zendesk's shares and squeeze its margins, but it should also significantly expand its ecosystem.
Zendesk's stock trades at just seven times next year's sales after its latest pullback. Salesforce trades at the same price-to-sales ratio despite growing at a slower rate. That valuation gap suggests that Zendesk's stock might rebound once it allays investors' concerns about the Momentive deal.
3. Datadog
Datadog's (DDOG -2.89%) platform enables IT professionals to monitor the performance of various servers, databases, cloud services, and mobile apps in real-time on its unified dashboards. That approach breaks down silos, saves a lot of time, and makes it much easier to spot potential problems.
Datadog's growth reflects its disruptive potential. Its revenue rose 83% in 2019 and grew 66% in 2020. It expects its revenue to rise approximately 65% this year. Its net retention rate has comfortably remained above 130% over the past year, and its number of customers that generated over $100,000 in annual recurring revenue (ARR) grew 66% year over year last quarter.
Like Palantir and Zendesk, Datadog is still unprofitable by GAAP measures. Its gross margins are also being squeezed by higher cloud hosting costs. However, Datadog turned profitable on a non-GAAP basis in 2020, and it expects its non-GAAP earnings to grow roughly 80% this year as it reins in its cloud spending.
Datadog's stock isn't cheap at 32 times next year's sales. However, its impressive growth rates and disruptive "silo-busting" potential could justify that higher valuation and make it a promising long-term investment.
