While most earnings calls offer a collection of valuable updates on a business's progress, management occasionally makes remarks that seem to jump right off the transcript.
That was precisely the case for me while I was browsing through DigitalOcean's (DOCN 3.78%) fourth-quarter 2021 earnings call when CEO Yancey Spruill stated:
At the same time, those customers spending less than $50 per month give us an incredible option on their future success. As so many of these customers will launch an idea that they test on DigitalOcean and ultimately turn it into a thriving and rapidly growing business.
Specifically, the word option in that quote immediately caught my attention. What a great way to explain DigitalOcean's upside potential: option-like.
Or, put another way, the company's focus on small and medium-sized businesses (SMBs) almost gives it the feel of an angel investor or venture capitalist of sorts. By offering its simplified cloud solutions to start-ups that are often barely more than a business idea, DigitalOcean is there at the beginning of the journey for most of its customers.
So why does this have me buying DigitalOcean shares as soon as possible? Let's take a look.
DigitalOcean's along for the ride
As of the fourth quarter of 2021, DigitalOcean had 609,000 customers -- yet only 99,000 (or 16%) spent more than $50 per month with the company. While saying this is a good thing for investors may sound counterintuitive, it is indeed a feature, not a bug. Consider that this 16% of customers account for 83% of the company's sales, and it's fair to say that DigitalOcean acts in a capacity similar to a venture capitalist -- just instead of capital, it provides simplified cloud computing.
Offering infrastructure as a service (IaaS) and platform as a service (PaaS) solutions, the company allows the 100 million SMBs across the world to "spend more time creating software that changes the world." Through this plan to jump in on the ground floor with thousands of young, upstart businesses, DigitalOcean has positioned itself to succeed as its customers thrive.
Perhaps due to this option-like potential, the market took notice of DigitalOcean shares, sending them as high as 200% after its early 2021 initial public offering.
While the company's shares have given up most of their gains over the last few months, the market opportunities in IaaS and PaaS for companies with less than 500 employees are $47 billion and $25 billion, respectively. Best yet for investors, these markets are expected to grow by about 27% annually through 2025. In Q4 2021, the company reported revenue growth of 37% over the year-ago period. With DigitalOcean generating revenue of $429 million in 2021 as a whole, its market share expansion opportunity is immense.
Multi-bagger stock potential with multi-bagger customers
By focusing on these SMBs across the globe, DigitalOcean develops strong relationships with its customers, offering support and a sense of community for small upstarts that its massive cloud peers often ignore -- or don't even notice. Due to this unique niche in its market, DigitalOcean's stock somewhat quietly masquerades as an investment portfolio.
Like many investment portfolios, most of the company's customers (stock picks) produce average returns, gradually growing over time, while a handful of its customers underperform and become less relevant. However, like some of the best investment portfolios, DigitalOcean's best customers post outsize returns, becoming well-known businesses of their own -- providing that option-like capability described by Spruill.
Admittedly an apples-to-oranges comparison, multi-baggers and options both (in different ways) offer undeniably significant return potential.
As DigitalOcean continues to grow its customer base, adding new possible high-flyers as it goes, it will simultaneously grow alongside its existing outperforming customers. This idea is much like buying and holding stocks for the long term and adding to winners over time.
Because of these "winning" customers, it will be crucial for investors to watch DigitalOcean's net dollar retention (NDR) in the future. Calculating the increase in sales among a company's existing customer base, including churn, an NDR above 100% shows growth within a business's operations.
This detail makes DigitalOcean's mark of 116% in Q4 of 2021 and its growth from 101% in Q1 of 2020 very impressive -- and more importantly, it shows that its high-flyers kept winning. Should DigitalOcean's NDR remain this strong or continue growing, look for its high revenue growth rates to become the norm -- likely propelling the company to become a multi-bagger of multi-baggers.