The tech-heavy Nasdaq-100 index has spent most of 2022 trading in bear market territory, which is defined as a loss in value of 20% or more from recent highs. Many investors are expressing concerns about a slowing economy, high inflation, and rising interest rates, so they're reconsidering their growth expectations for high-flying technology stocks.
Some quality stocks have been caught up in the sell-off and are trading down significantly for reasons not really connected to performance. These stocks are likely to rebound in the long run, creating a great opportunity to put some money to work while such companies are trading at a discount.
DigitalOcean Holdings (DOCN -4.06%) is a provider of cloud services that is competing against multitrillion-dollar giants and finding enormous success. One Wall Street investment firm, in particular, thinks its stock could more than double to $80 a share from its current price of $35.24. Here's why.
DigitalOcean has a fast-growing opportunity
The cloud services industry continues to expand not only in value, but also in scope. Amazon Web Services is regarded as one of the pioneer providers in this sector, starting out in 2006 by offering its customers a new way to store data. Since then, the industry has grown to offer hundreds of different services and solutions, including website hosting, software development, advanced artificial intelligence, and machine-learning tools.
Estimates by Grand View Research suggest the cloud services industry could be worth over $1.5 trillion annually by 2030. DigitalOcean is an upstart $3.6 billion company walking among giants, but it has found a lucrative niche by catering to small and mid-size businesses.
Its ideal customer is a start-up or an organization with under 500 employees, which is a segment of the cloud market it estimates will be worth $72 billion in 2022. But the company believes its market could more than double to $145 billion by 2025. It competes with larger providers by offering lower prices, an easy-to-use dashboard, and (thanks in part to its acquisition of CSS Tricks) by providing thousands of items of educational material to help customers get the most out of their cloud services.
DigitalOcean's plans start at $0 to $15 per month, and its ease of use means it also reduces the cost burden of having dedicated technical staff to manage cloud operations.
DigitalOcean has more customers, spending more money
DigitalOcean estimates there are 100 million small to mid-size businesses in its target market around the world. According to its recent first-quarter 2022 earnings report, it has captured 623,000 of them so far across the 185 countries it operates in.
The company says 102,500 of those customers are spending more than $50 per month on its services, and the monthly average revenue per user continues to climb to all-time highs. It reached $68.90 in the first quarter of 2022, which was a 28% jump from the year-ago period, and 54% higher than the 2020 first quarter.
DigitalOcean's net dollar retention rate is also moving higher consistently, most recently topping 117%. That means existing customers spent 17% more with the company than they did in the previous period, so its growth isn't just coming from new sign-ups.
DigitalOcean stock is a great value
Over the last four quarters, DigitalOcean has delivered $462.2 million in revenue. It has averaged 36% year-over-year growth in each of those quarters, a result of the positive metrics mentioned above.
That places the company's stock at a price-to-sales (P/S) ratio of 7.8, which is about the cheapest it has ever been since listing publicly in March 2021. At the stock's all-time high price of $133.40, its P/S was four times higher, at 31.
Therefore, despite DigitalOcean's revenue averaging the fastest growth rate in its history, along with having its highest-ever customer count, its stock is as cheap as it has ever been. The broader tech market sell-off is the primary reason, because investors are shunning companies that aren't making a profit even if they're high-quality businesses.
DigitalOcean lost $18 million in the first quarter of 2022, but that's primarily because the company doubled its administration costs and nearly doubled its investment in marketing year over year, which are both warranted expenses given that it is expanding so quickly. Since the cloud-services industry opportunity is so large, it's important to continue capturing as much market share as possible.
Wall Street investment firm Oppenheimer is keeping the faith, tacking an $80 price target onto DigitalOcean stock, which represents 127% upside from where it trades at the time of this writing.