When trying to find a good stock to invest in, I often start by looking for large and growing market opportunities. Cloud computing is one such space.
According to Grand View Research, the market is already quite large. It's estimated to be $369 billion at the end of 2021, when including infrastructure, software, and platform services. But cloud computing is still very much in growth mode -- Grand View Research predicts it will grow at a 15.7% compound annual growth rate from the end of 2021 through 2030.
When it comes to the cloud-computing space, Amazon's AWS and Microsoft's Azure are the leaders. But even though it's small with a market capitalization of just $2.6 billion, DigitalOcean (DOCN -0.05%) is a cloud-based growth stock with market-beating potential. It's also a company investors should take a serious look at in the current bear market in tech. Here's a closer look at what makes DigitalOcean stand out from the pack.
DigitalOcean's business
When it comes to DigitalOcean's competitiveness, it claims to have a clearer pricing structure than AWS. Of course, DigitalOcean is the one saying this, so take the claim with a grain of salt. But whether it's clear pricing or something else, something is apparently working for the company, as evidenced by the size of its customer base.
As of the end of the third quarter of 2022, 142,000 businesses were spending at least $50 monthly for DigitalOcean's services. The company added 20,000 new customers during Q3 through its $350 million acquisition of Cloudways. But it organically added 17,000 during the quarter as well.
DigitalOcean's business model is usage-based -- its small and medium-sized business customers are charged based on how much they use the platform. This gives the company upside as its customers grow. It also has upside as customers adopt more than one product.
Of course, this business model also has downside. If the economy slows and businesses use DigitalOcean's services less, its revenue could go down. And considering that many economists predict a recession in 2023, this is a contributing reason why DigitalOcean stock has dropped 79% from its high -- investors worry its usage could drop.
However, there's another side to this coin that's under-appreciated: DigitalOcean's customers don't have to cancel if they fall on hard times. As CEO Yancey Spruill said on a recent conference call, customers can "adjust their use to address any economic headwinds they are facing." That's much more palatable than losing customers altogether and positions DigitalOcean to rebound when its customers do.
For what it's worth, DigitalOcean's business is still performing quite well. It's on pace to report revenue of $573 million to $575 million in 2022. For perspective, that's about 34% more than the $428.6 million it generated in 2021.
The case for DigitalOcean stock
DigitalOcean's management doesn't intend for 2022 to be the last year of growth. To the contrary, it's aiming for $1 billion in annual revenue by the end of 2024.
To reach this goal, DigitalOcean will try to grow average revenue per user (ARPU) by upselling more products. This is an existing trend. In Q3 2022, ARPU was $79.22, up 28% year over year. And the company hopes to add many new customers, as it has done over the past year.
To do this, DigitalOcean is spending more on sales. Through the first three quarters of 2022, the company spent $56.4 million, up 59% from the $35.5 million it spent during the comparable period of 2021. Spruill says this is intentional and will continue.
I know what value investors are thinking -- that sounds expensive. However, investors should keep in mind that Spruill loves profits, and specifically free cash flow, which he calls his "obsession." When he joined DigitalOcean in 2019, it was burning through cash. However, the company is now free cash flow-positive, and Spruill intends to keep it that way even as he spends to grow revenue.
Growing and profitable, DigitalOcean looks like it's on the right course to claim its share of the massive cloud-computing market. And trading at just 5 times its trailing sales, this looks like one of the better value opportunities in the tech space right now.
DOCN PS Ratio data by YCharts
It could be another wild year for stocks in 2023, and shares of DigitalOcean could certainly get cheaper -- I'm not calling a bottom.
However, in DigitalOcean, I see a company going after a large opportunity, growing, generating profits, and trading at a valuation that makes sense if it stays on course over the next three to five years. That's why I believe this could be a market-beating opportunity.
