Is Datadog Stock a Buy?

Datadog (DDOG 1.65%) posted its third-quarter earnings report on Nov. 3. The data visualization company's revenue rose 61% year-over-year to $437 million and beat analysts' estimates by $22 million. Its adjusted net income increased 83% to $81 million, or $0.23 per share, which also cleared the consensus forecast by seven cents.

Datadog's growth rates were impressive, but its stock barely budged after the report and remains down nearly 60% for the year. Let's review Datadog more closely to see if it's worth buying at these levels.

Image source: Getty Images.

Still a hypergrowth stock

Datadog's platform collects diagnostic data from a company's servers, databases, and apps in real time, then aggregates all of that information onto unified visual dashboards for IT professionals. This silo-busting approach makes it easier to spot potential problems before they occur.

The market's demand for its services is skyrocketing: Datadog's revenue rose 66% in 2020, and surged another 70% to $1.03 billion in 2021. Here's how rapidly it's grown over the past five quarters.

Data source: Datadog. YOY = Year-over-year.

For the full year, Datadog expects revenue to rise 60%-61% and for its adjusted EPS to increase 88%-92%. It had previously expected revenue to rise 56%-58%, and EPS to grow 54%-81%.

Locking in high-value customers

In addition to that rosier guidance, Datadog continues to gain large customers that bring in more than $100,000 in annual recurring revenue (ARR). That high-value cohort expanded from just 858 customers at the end of 2019 to 2,600 in its latest quarter. The company now generates about 85% of its revenue from those larger customers.

Data source: Datadog.

Datadog's dollar-based net retention rate, which measures its year-over-year revenue growth per existing customer, has also remained comfortably above 130% over the past year. Some 80% of its customers are now using two or more of its products, compared to 77% a year earlier, while 40% were using four or more of its products, compared to 31% a year ago.

Stable gross and operating margins

On a non-GAAP (generally accepted accounting principles) basis, Datadog's gross and operating margins expanded year-over-year in the third quarter, but dipped slightly from the second quarter.

Data source: Datadog.

During the conference call, CFO David Obstler attributed the company's year-over-year margin expansion to "efficiencies in cloud costs," and expects its adjusted gross margin to remain in the "high 70s" in the "medium to long-term."

Datadog also recently acquired the cloud infrastructure visualization service Cloudcraft to expand its platform, but Obstler noted that it was a "small company" which would generate an "immaterial amount of revenues."

Two bearish arguments

Datadog's growth rates are impressive, but its GAAP numbers -- which factor in its stock-based compensation (SBC) and other one-time expenses -- highlight some underlying weaknesses. Its GAAP operating margins notably turned negative over the past two quarters, and it racked up net losses over the past two quarters as it ramped up its spending.

Data source: Datadog.

Bulls believe those numbers will improve once Datadog reins in its SBC expenses, which gobbled up 21% of its revenue in the first nine months of 2022, but the bears will argue that this red ink will limit its upside potential as interest rates continue to rise.

The bears also likely believe Datadog's stock is still too expensive, especially as rising rates drive investors toward cheaper stocks. Its enterprise value of $22.7 billion still values the company at about ten times next year's sales.

A better value than some peers

I believe Datadog's high growth rates still justify its higher valuation. It's already gotten a lot cheaper over the past year; at its peak of $196.56 last November, it was valued at $60.6 billion, or 37 times the revenue it now expects to generate in 2022.

It's also cheaper than other hypergrowth stocks like Snowflake, which is growing at a comparable rate but trades at 14 times next year's sales. Cloudflare, which is growing at a slightly slower pace, trades at 13 times next year's sales. Datadog's GAAP profits are volatile, but it's still in better shape than these and other hypergrowth cloud companies that have yet to generate a single quarter of GAAP profits.

Therefore, Datadog is definitely a risky stock -- but I believe it's still a great long-term buy for patient investors at these levels.