Tech stocks with high valuations have been getting crushed recently. The tech-heavy Nasdaq Composite index is down more than 25% year to date, and many other tech stocks have fallen even further. However, there are a few businesses that are falling despite near-perfect fundamental execution.
One of the best examples of this type of company is Datadog (DDOG -2.68%). The stock has fallen over 45% in 2022, yet the business is continuing to put up jaw-dropping results. Datadog is also seeing significant improvements in its profitability and cash flow, which is not common among other high-growth stocks.
Because of this and because of the opportunities it has over the next five years, Datadog is one of the best stock opportunities I see on the market right now.
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Datadog is seeing the future of observability
Datadog specializes in helping businesses make sure their cloud applications are running smoothly and performing to the level that customers expect. The company started as a unified data platform, but it has since reached into infrastructure, user experience, and security monitoring. It now has 26 tools to ensure a business' cloud infrastructure is running smoothly, and it is one of the top dogs in the application performance monitoring space, according to Gartner.
How has Datadog become one of the leaders in this space? The company continues to create stronger products with more integrations to make its platform more valuable to its users. The company made strides on this in Q1, namely in its partnership with Microsoft. This partnership puts Datadog in Azure's Cloud Adoption Framework, which will help Datadog be seen by Azure customers that are starting their journey in the cloud. This is yet another feather in the cap of Datadog, further establishing its capabilities.
At the same time, the company is rapidly expanding into new markets, one of the most recent being the public sector. At the end of 2022, the company got FedRAMP Authorization, which allows it to sell to the government and public sector.
Adoption is paying off
This continuous innovation has paid off immensely. The company now has nearly 20,000 customers, who are rapidly expanding their relationships with Datadog. Its net retention rate was over 130% in Q1, marking the 19th consecutive quarter of retention rates exceeding 130%. These users seem to be spending more because of increased product usage. At the end of Q1, 35% of customers used four or more Datadog products. It was 25% of customers a year ago.
As long as Datadog continues to have best-in-class products, these customers will likely continue increasing their usage, which will allow Datadog to maintain its leadership.
The competitive advantages and increasing customer loyalty the company is seeing are paying off financially. In Q1, Datadog saw 83% year-over-year revenue growth to $363 million. What's even more impressive, however, is the company's ability to turn that growth into cash flows and profitability. Its net income reached $9.7 million in Q1 2022, which jumped from a loss of $13 million in Q1 2021. Additionally, the company's free cash flow soared a staggering 192% to $130 million over the same period.
Datadog faces stiff competition from companies like Dynatrace and New Relic, but despite this, the company is making impressive progress on both its top and bottom lines.
Datadog is barking up the right tree
If the company continues to use its edge to see more adoption, Datadog could capitalize on a massive market. It believes its total opportunity in the observability space is $42 billion today, but it could become $53 billion by 2025. The company is expecting just $1.61 billion in 2022 revenue, meaning that there is still plenty of room for Datadog to expand going forward.
Aside from competition, the main risk for Datadog is its very high valuation. The stock trades above 33 times sales and 135 times free cash flow, so it's by no means cheap right now. That being said, this business is performing at an all-time high, and with its major potential, Datadog looks appealing to own for the long term. Because of its high valuation, you might want to dollar-cost average into a position rather than buying in full.
While this stock has a high valuation, that doesn't mean you should pass on it. The company is operating in a massive space and as one of the dominant forces with multiple competitive advantages. All this means you should consider owning shares of Datadog.
