The stock market sell-off has been ruthless in 2022, especially for technology companies. The tech-heavy Nasdaq Composite index is down over 7% this year, and many individual stocks have fallen even harder. Both DigitalOcean Holdings (DOCN -2.79%) and Amplitude (AMPL -5.22%) were hit considerably more than the index, falling 25% and 64%, respectively, during the same period.
At valuations much more appealing than in the past, both companies have the potential to provide great returns over the next five years. But which company has the best chance of doing so?
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DigitalOcean
DigitalOcean is providing unrivaled support to small and medium-sized businesses (SMBs) with its cloud offering that has attracted over 609,000 customers. It faces competition from the cloud behemoths like Amazon (AMZN -1.35%) Web Services, but AWS has several problems that make its platform difficult for SMBs to use. First, its product suite is very complex. This might be a highlight for a large enterprise with a team of expert application developers, but for an SMB with little cloud experience, this can make its platform difficult to use. Second, giants like AWS do not have the level of customer support that SMBs or amateur developers require.
DigitalOcean has noticed this and created a solution specifically for SMBs and independent developers. The company keeps its product line simple, offering just the core products on its platform. It also has a community where SMBs can access a large library of tutorials to learn more about how to operate on the cloud.
This unique offering was developed specifically for SMBs, and while the companies like AWS could potentially develop a competing platform, it would likely be much harder than it seems. First, it would take a lot of investment to rebuild a community like DigitalOcean's, and even that would not guarantee that it would take market share. Second, this niche is not as valuable as the enterprise market AWS specializes in. AWS has customers like Netflix that likely spend millions of dollars on the platform. DigitalOcean's customers, however, spent an average of $66 in the fourth quarter, so the investment AWS would have to make might simply not be worth it.
For DigitalOcean, however, this SMB niche is lucrative. The company estimates that its annual addressable opportunity is worth $72 billion today, and that is expected to grow to $145 billion by 2025. Considering the company had just $429 million in revenue in 2021, the opportunity for DigitalOcean to grow remains enormous. Even at its small scale, the company is putting up impressive results. Its free cash flow for the year was almost $30 million, up from a free cash flow burn of $52.4 million in 2020. This puts the company on track to reach its aspirations of 20% free cash flow margins by 2024.
With the stock being hit hard over the past few months, shares trade at 13 times sales -- a cheap price for a company with dominance in its niche.
Amplitude
Amplitude is also operating in a massive market, worth $37 billion annually. The company is reinventing how businesses develop their products by relying on first-party data rather than third-party resources. Finding pain points in your product experience from your own customers is an effective way to create better digital products, and Amplitude is the leading analytics platform to help businesses do this.
Amplitude's leadership in this growing space has attracted dozens of big-name companies, including Ford and Peleton. This high adoption from established companies like these has resulted in revenue reaching $167 million in 2021, which grew 63% year over year.
The company's profitability is a concern, however. Its net loss grew 205% year over year in 2021, and its free cash flow burn topped $35 million. A company burning this much cash is risky, and this has worsened: In 2020, its burn was just $13 million.
Better Buy: DigitalOcean
Amplitude is trading at a rock-bottom valuation of just 11 times sales -- lower than DigitalOcean -- but the latter is still a better buy today. Both companies have tons of potential, but DigitalOcean has seen much more success at scale than Amplitude. Additionally, DigitalOcean has more than 609,000 customers -- much bigger than Amplitude's 1,600 customer count.
Another reason DigitalOcean stands out is because of its impressive cash flow generation. Its cash flow margin reached 7% in 2021, so while it is strong today, the room to expand over the next few years is still large. Amplitude's free cash flow, on the other hand, has consistently been negative. For fast-growing tech stocks, cash flow is vital to continue innovating and creating strong products. Amplitude runs the risk of choosing between staying alive or innovating with its cash burn, which could put the long-term success of the company in jeopardy. For these reasons, it might be smarter to invest in DigitalOcean today.
