DigitalOcean Stock Is Up Over 30% So Far in 2023 -- Is It Too Late to Buy?

DigitalOcean (DOCN 0.95%) is keeping up with the Joneses. Revenue increased 36% year over year in the fourth quarter of 2022, impressive considering most of the public cloud giants reported a sharp deceleration in growth as the global economy slammed on the brakes after the U.S. Federal Reserve's aggressive interest rate hikes last year.  

As a result, DigitalOcean's stock has rallied over 30% so far in 2023. It isn't the value it was a few months ago, but there's still plenty to like about this top computing technology company.  

Stacking DigitalOcean against the cloud titans

DigitalOcean's $576 million in revenue in 2022 is a pittance compared to the billions of dollars that cloud titans Amazon (AMZN -1.64%) AWS, Microsoft (MSFT 0.37%) Azure, and Alphabet's (GOOGL 0.55%) (GOOG 0.74%) Google Cloud haul in each quarter. DigitalOcean is undeterred, though. Its focus on updating small and mid-sized businesses for the cloud era (where a remote data center handles the heavy lifting and computing services are accessed via the web) is paying off even in a challenging economic climate. 

All quarters refer to calendar year 2022 growth, as Microsoft's fiscal year ends at the end of June every year. Data source: DigitalOcean, Amazon, Microsoft, and Alphabet.

Of course, DigitalOcean did get a small boost in the third and fourth quarters from its acquisition of managed hosting services company Cloudways back in September 2022. Nevertheless, DigitalOcean's consistent and high growth rates are impressive, considering it has been contending with the same record run-up in the U.S. dollar (again, thanks to the Fed's interest rate hikes) as its far larger peers. All along the way, it has remained profitable on a free-cash-flow basis, and it's nearing breakeven on an unadjusted basis too.  

Full-year 2022 free cash flow was $78 million, up 218% from 2021 and representing a free cash flow profit margin of 13.5%.  

Strong growth and more profitable growth

At the midpoint of 2023 guidance, DigitalOcean is forecasting revenue growth of 23% to $710 million. Clearly, economic challenges are beginning to more deeply impact the small-business customer base. CEO Yancey Spruill said on the earnings call that the annual $1 billion-revenue goal is being moved back from 2024 to 2025.

However, the other half of Spruill and company's goal -- 20% or better free-cash-flow profit margin -- is being moved up to 2023. The outlook calls for free cash flow to be 21% to 22% of revenue for full-year 2023. Paired with the (albeit slower) revenue growth, that implies free cash flow will be in the range of $149 million to $156 million this year, nearly double what it was in 2022.

Is the stock a buy?

Clearly, the latest quarterly update was one of puts and takes. I do believe the company could be sandbagging and might surprise to the upside on its revenue growth, especially if the U.S. dollar continues to give back a little value compared to other currencies. However, given the tough economic environment, DigitalOcean is slowing its growth plans but reprioritizing profits. It also announced another share repurchase plan of up to $500 million to be executed in 2023, implying management's confidence that shares are trading for a long-term value.  

DigitalOcean stock currently trades for about 22 times the forecast 2023 free cash flow. I expect plenty of turbulence in this stock as the company reports slowing growth and macroeconomic data gets digested by investors in the coming year. However, at this price, DigitalOcean looks like a best buy to me right now, stacked up against its cloud titan peers.