What happened

Shares of Datadog (DDOG 1.24%) were down 20.3% in April, according to data provided by S&P Global Market Intelligence. The cloud monitoring and security stock delivered a much larger loss than the S&P 500's 8.8% decline.

The stock market has been severely punishing expensive, unprofitable tech stocks with slowing growth, but Datadog doesn't fit that mold. Revenue is soaring, and the company is even reporting generally accepted accounting principles (GAAP) profits. But as interest rates rise and investors fret about a possible recession, sky-high valuations are becoming a thing of the past.

A digital representation of a cloud.

Image source: Getty Images.

So what

Datadog hasn't been hit as hard as some other pandemic high flyers, and that's likely because the company isn't seeing any kind of slowdown. Revenue surged 84% in the fourth quarter of 2021, and it grew by 83% in the first quarter of this year.

From their all-time high in 2021, shares of Datadog are down around 42%. That's a big drop, but it's nothing compared to other growth stocks that have been decimated in recent months. The list of stocks that have lost at least three-quarters of their value since peaking seems to be getting longer by the day.

What's particularly impressive about Datadog's growth is that it hasn't come at the expense of profitability. The company was profitable on a GAAP basis in the first quarter, not a common sight in the world of software-as-a-service stocks, and free cash flow was soundly positive.

Valuation is really the only problem, and it's something that investors can't ignore as interest rates rise. As recently as late 2021, Datadog traded above 60 times sales. Pre-pandemic, that kind of valuation would have seemed ludicrous. Datadog traded for around 10 times sales soon after it went public in late 2019, for example.

Following its decline, Datadog still sports a price-to-sales ratio of around 34. Even if Datadog does everything right, keeping up its growth rate and improving margins, the stock could slump further. And if anything goes wrong, watch out below.

Now what

Datadog's long-term growth story is as strong as ever. The company follows a land-and-expand model, snagging new customers with any of its various products, then selling them on additional products that expand functionality. A customer could start with basic log management, then upgrade to take advantage of Datadog's application performance monitoring solution.

There's little question that Datadog is a great company, but there's no telling whether it will prove to be a great stock in the near term. What's the correct price-to-sales ratio for a stock like Datadog? Who knows? A year ago, paying 40, 50, or even 60 times sales was something investors were willing to do. That's just not the case anymore.

In the long run, Datadog has all the makings of a good investment. But it's unlikely to be a smooth ride for investors.