A 2022 examination of the information technology sector (let alone individual companies in that sector) would have just about any investor second-guessing the decision to go anywhere near it. The Nasdaq Composite index is largely made up of companies in the information technology sector, particularly software companies. Right now, the Nasdaq is trading down about 28.4% in 2022.
Looking at that poor stock performance, it would seem most software and information technology companies did poorly this year. In some instances, the drop in valuation is truly warranted. Investors got caught up in a meme-stock euphoria in 2021 and several companies ended up overvalued based on short-term thinking. The stock price action this year has corrected the overenthusiasm.
With the final quarter of the year well underway, some companies have corrected to a point where buying again looks appealing. Whether you are lowering your cost basis or initiating a new position, here are two high-growth software companies with stocks now priced to be big winners over the long term.
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1. Datadog
Datadog (DDOG 3.58%) provides companies with a software platform that monitors cloud-scale applications, servers, databases, tools, and services to generate data analytics and ensure security. Its services are in high demand that is expected to keep growing well into the future.
The growing demand can be seen in the table below showing Datadog's revenue and gross margin trends for the last four full fiscal years:
| Metric | Fiscal 2018 | Fiscal 2019 | Fiscal 2020 | Fiscal 2021 |
|---|---|---|---|---|
| Revenue | $198.1 million | $362.8 million | $603.5 million | $1,028.8 million |
| Gross profit | $151.5 million | $273.8 million | $473.3 million | $794.5 million |
| Gross margin | 76% | 75% | 78% | 77% |
Data source: Company filings and investor presentations. Notes: Dollar amounts in millions. The fiscal year ends Dec. 31 of each year.
One reason Datadog saw such an uptick in demand is that its platform is positioned at the intersection of two growing addressable markets: big data and security. Additionally, data analytics and security are even more important to companies operating in the cloud. Datadog's software has an edge here because it can integrate information from different cloud computing platforms, including Amazon's AWS, Microsoft's Azure, and Alphabet's Google Cloud. This has helped Datadog boost revenue by more than two-thirds year over year since 2018, all while maintaining an enviably high gross margin.
Since its initial public offering (IPO) in September 2019, Datadog's stock price is up 136%, and that's even after a 50% price drop so far in 2022.
Despite generating strong top-line growth and margin expansion throughout 2022, it is fair that some investors may fear a slowdown or plateau in growth is imminent. For example, given the existing and likely future interest rate hikes from the Federal Reserve, some may be concerned that corporate spending and budgeting will tighten, threatening Datadog's growth. Additionally, while Datadog has quite an enviable gross margin, the company is not consistently profitable. With the stock price drop this year, these factors are now priced into the stock. Going forward, the company has a real path to further growth that should eventually account for the current headwinds. An analyst at investment firm Canaccord Genuity last week upgraded its recommendation on Datadog from a hold to a buy status, citing strong demand and accelerating growth as catalysts.
2. MongoDB
Database specialist MongoDB's (MDB 7.69%) weird name is kinda funny (it's a reference to the humongous database the company developed). But this company's software is tackling quite a serious business: database management.
In the world of big data, many companies still leverage relational databases. At a high level, relational databases are organized as a series of columns and rows to build large tables and synthesize data. However, as corporations grow and invest more heavily in digital transformation through enhancements such as CRM systems from companies like Salesforce, HR platforms such as those used by Workday, or accounting software like what Oracle markets, data quickly becomes distributed and unstructured. This means that data is hosted in systems that do not connect with one another seamlessly, thereby making important data-driven insights challenging and inefficient. MongoDB offers a software platform that allows for easier data migration from disparate systems.
Like with Datadog, the services MongoDB provides are in high demand. The table below illustrates Datadog's revenue trends for the past four fiscal years (each ending Jan. 31):
| Metric | Fiscal 2019 | Fiscal 2020 | Fiscal 2021 | Fiscal 2022 |
|---|---|---|---|---|
| Revenue | $267 million | $421.7 million | $590.4 million | $873.8 million |
| Revenue Growth (YOY) | N/A | 57.9% | 40% | 48% |
| R&D Costs | $89.9 million | $149.0 million | $205.2 million | $308.8 million |
| R&D as % of Revenue | 33.7% | 35.3% | 34.7% | 35.3% |
Source: MongoDB earnings reports. Note: Fiscal year ends Jan. 31 of each year referenced and mostly relates to performance from the previous calendar year. YOY = Year over year. R&D = Research and development.
Investors can see that demand for MongoDB's services have been robust over the last several years. Additionally, MongoDB has been allocating nearly one-third of its costs to research and development. On the surface, this appears to be paying off as the company's top-line growth has been exceeding its reinvestments back into the business. However, some investors may argue that management should ratchet up these investments given the strong demand for the product. While I can see both sides to the argument, I am more comfortable with management sustaining investment levels rather than increasing them during times of wide economic uncertainty.
MongoDB's stock has performed well since its public market debut in 2017. The stock is up an eye-popping 508% since its IPO. That rise is in spite of the 63% price drop just in 2022.
Keep an eye on valuation
Given that both MongoDB and Datadog serve important and growing markets, investors may be scratching their heads as to why the stock prices are down so much in 2022. On the surface, both of these companies look like disruptive technology players. Why is there hesitancy to buy these discounted stocks?
MongoDB has a market capitalization of about $13 billion and trades at 12 times trailing-12-month sales. However, the company has yet to generate consistent profits as it is still very much in growth mode even after five years as a public company.
The younger Datadog has a market capitalization of $26 billion and trades at 20 times trailing-12-month sales. Datadog is net income positive through the first two quarters of the year; however, the company is not yet consistently profitable each individual quarter. While Datadog's management guided toward full-year 2022 profits on a non-GAAP basis, it is imperative for investors to understand that non-GAAP profitability does not mean the company is truly generating positive net income. However, by demonstrating it has the ability to move cost levers while still generating strong top-line growth in individual quarters should provide investors with some assurance that management has the right playbook for long-term consistent profits.
While cratering stock prices can make a company appear risky, both Datadog and MongoDB are investing in high-growth areas that yield consistent customer demand. Even though software stocks have taken a big hit throughout 2022, the long-term potential of each stock provides investors with a view of what the future could hold, so long as each company keeps up the strong growth. If you are bullish on big data analytics and security in the cloud, each of these stocks presents a very nice opportunity to initiate a position or lower your cost basis if you already own and are considering buying more.
