5 Green Flags for Datadog's Future

Datadog's (DDOG -2.68%) stock jumped 12% on Feb. 10 after the cloud-based software company posted its fourth-quarter earnings.

Its revenue rose 84% year-over-year to $326.2 million, beating estimates by $34.8 million. Its adjusted net income jumped 268% to $70.2 million, or $0.20 per share, which also surpassed expectations by nine cents.

Those headline numbers were impressive, but a deeper dive into Datadog's report reveals five bright green flags for this high-growth company's future.

Image source: Getty Images.

1. A growing number of large customers

Datadog's platform monitors the performance of different servers, databases, cloud services, and apps across an entire company. It aggregates all of that real-time data on unified dashboards, which makes it much easier for IT professionals to spot and diagnose potential problems.

This silo-busting approach is catching on with big enterprise customers. Datadog ended the quarter with 216 customers with annual recurring revenues (ARR) of at least $1 million, an increase of 114% over a year ago. Its number of customers with an ARR of at least $100,000 rose 63% to 2,010.

2. A high net retention rate

Datadog doesn't report its exact dollar-based net retention rate, which gauges its year-over-year revenue growth per customer, every quarter.

But during the conference call, CFO David Obstler said that metric had exceeded 130% for the 18th consecutive quarter. Datadog maintains that high net retention rate with its "land and expand" strategy, in which it locks in customers with one or two products to cross-sell additional products.

At the end of the fourth quarter, 78% of Datadog's customers were using two or more of its products, up from 72% a year ago. Some 33% were using four or more of its products, versus 22% in the prior-year quarter, while 10% were using six or more products, compared to just 3% last year.

3. Accelerating revenue growth (in 2021)

Datadog's expanding customer base, high retention rate, successful cross-selling strategies, and a few smaller acquisitions enabled it to generate accelerating year-over-year revenue growth throughout fiscal 2021:

Data source: Datadog. YOY = Year-over-year.

For the first quarter of 2022, Datadog expects its revenue to rise 68%-70% year over year, which easily tops analysts' expectations for 54% growth.

For the full year, it expects its revenue to grow 47%-49%. That would represent a slowdown from its 70% growth in 2021, but it's still much higher than the consensus forecast for 36% growth.

4. Stable gross margins

Datadog's adjusted gross margin also hit 80% during the fourth quarter, compared to 78% in both the previous and prior year quarters.

It mainly attributed that expansion to more efficient cloud hosting costs. Over the "medium to long term," Obstler expects Datadog's adjusted gross margin to remain in the "high 70s range" -- which indicates it still has plenty of pricing power in its high-growth niche market.

5. Improving GAAP profitability

Many high-growth software companies generate robust revenue growth with stable gross margins, but struggle to squeeze out meaningful operating and net profits. Yet Datadog's operating margins have been consistently expanding -- by both generally accepted accounting principles (GAAP) and non-GAAP metrics -- over the past year:

Data source: Datadog.

Obstler attributed that ongoing expansion to "significant business efficiencies on strong revenue growth," which offset its "aggressive investments" in "long-term opportunities, particularly in R&D and go-to-market." Those investments include its acquisitions of Timber, Sqreen, Ozcode, and CoScreen over the past year.

That operating efficiency enabled Datadog to squeeze out a slim GAAP profit of $7.2 million in the fourth quarter, which represented a major improvement from its net loss of $16.2 million a year earlier.

For the first quarter, Datadog expects its non-GAAP earnings per share (EPS) to rise 67%-100%. But for the full year, it expects its non-GAAP EPS to come in roughly flat as it integrates its new acquisitions and ramps up its investments.

But is Datadog's stock worth buying?

Datadog's growth rates are impressive, but a lot of growth is already baked into its stock at 36 times this year's sales. However, there are still plenty of other high-growth software stocks that are trading at higher valuations.

Snowflake (SNOW -1.00%), which also breaks down silos with its cloud-based data warehousing service, trades at nearly 80 times this year's sales. Analysts expect its revenue to more than double this year -- but it remains deeply unprofitable by both GAAP and non-GAAP measures.

Cloudflare (NET -3.34%), which provides content delivery and website security services, trades at 57 times this year's sales. Analysts expect its revenue to rise 52% this year -- but it's also unprofitable by GAAP and non-GAAP measures.

Datadog seems reasonably valued relative to those high-growth software peers, and it's actually slightly profitable on a GAAP basis. Therefore, I think investors who can stomach all the near-term volatility should accumulate some shares of Datadog right now. Its valuations make it a bit speculative, but all of its core growth metrics are headed in the right direction.