Sometimes you can't fight the market; a company can do everything right, but it might not matter if the market's throwing out the metaphorical baby with the bath water. Fortunately, that can mean an excellent opportunity for a savvy investor, picking up quality stocks that are on sale for no reason other than everything else is falling.
Cloud observability company Datadog (DDOG 3.50%) is checking the boxes that make a great company and investment over the long term. Yet the stock has fallen more than 60% from its peak. I'll dive into what makes Datadog a stock worth considering and outline why now is a great time to think about adding it to your diversified portfolio.
1. Datadog offers a fantastic product
Software is increasingly moving to the cloud. Back in the day, a company would buy software and install it individually on every computer using it. But cloud-based software is different; users can access it through the internet, which makes it easier to implement across a company and can be updated in real-time. However, executing various applications and getting them to work together can be a challenging task.
Datadog is an observability and analytics tool; information technology (IT) departments use it to monitor their apps, data centers, and servers for events and performance, troubleshoot problems, and keep their systems secure. You can think of them as the watchdog (see what I did there?) that oversees a company's technology systems to ensure they run as smoothly as possible.
Companies spend thousands to millions on enterprise software and other technology, which makes monitoring a critical role. Third-party technology research firm Gartner named Datadog as a 2022 industry leader for application performance monitoring and observability. That reputation has translated into numbers; Datadog's customer base has grown from 5,403 five years ago to 22,200 today.
2. It has sparkling clean financials
Acquiring customers and getting them to increase their spending over time (Datadog has a net revenue retention rate of 130%) has fueled 50% or higher revenue growth since the stock went public. In fact, it now does $1.4 billion in annual sales. Some companies grow at any cost, but Datadog generates strong cash profits; it turns $0.26 of every revenue dollar into free cash flow.
DDOG Free Cash Flow data by YCharts
That's a big deal during tough times, since investors don't need to worry about Datadog having to raise more cash out of desperation. Rather, its business is organically putting cash on the books ($1.7 billion in cash and marketable securities), even with the company still chasing growth. This profitable growth is a sign of a great business model.
3. Datadog's stock also has an attractive valuation
A company with a quality product and robust financials is one that many investors seek, which is why Datadog spent much of 2020 to 2022 as one of Wall Street's more expensive stocks. The company once commanded a price-to-sales ratio (P/S) of more than 60, a hefty valuation that's tough for even a quality stock like Datadog to maintain over time.
You can see below that the drop in shares has pulled that P/S ratio back down to earth, helped by Datadog's swift growth:
DDOG PS Ratio data by YCharts
With Datadog now at a P/E of just 13 on a forward basis, investors could see its organic growth lift the share price over the coming years. The company just turned in 61% year-over-year revenue growth in the third quarter, so Datadog still looks like it's maintaining momentum. Management believes that its addressable market will grow to $62 billion by 2026, so there could be a lot of juice left for investors as long as it continues to provide a quality product that enterprises love.
