DigitalOcean (DOCN -2.55%) differs from the Amazon Web Services (AWS) and Microsoft Azures of the cloud computing industry by targeting small and medium-sized businesses. Its approach has attracted interest from that target market.

Additionally, after having lost most of its value over the last 17 months, its lower stock price could help make DigitalOcean stock a buy now. The question for investors is whether that lower price and the company's other attributes outweigh a critical threat that could hamper DigitalOcean and its stock.

Reason to buy: DigitalOcean's niche

DigitalOcean stands out in its industry in two critical ways. First, it offers a simple, a la carte pricing model that appeals to small and medium-sized businesses. Second, its DigitalOcean Community provides online resources and connections to other DigitalOcean clients when a business needs to solve a problem.

This fills a critical need because almost 79% of U.S. businesses employ fewer than 10 people, according to the U.S. Census Bureau. Such companies may have one-person IT departments or no IT people at all. Hence, solving IT issues may fall on a non-IT person, making the DigitalOcean Community critical to a company's success. That factor may explain how DigitalOcean has grown its client base to 677,000 customers.

Reason to buy: DigitalOcean's improving financials

With that customer base, DigitalOcean generated $576 million in revenue in 2022, a 34% increase from year-ago levels. This included a net dollar retention of 115%, meaning the average customer of one year or more increased spending on the platform by an average of 15%.

As a result, DigitalOcean earned a non-GAAP net income of $105 million, up from $43 million the year before. The company also predicts an increase of approximately 80% in non-GAAP income for 2023, which would bolster its profitability.

Reason to buy: Stock and valuation

But while those improving financials could help the stock, DigitalOcean continues to reel from a 75% stock decline from its November 2021 peak. 

Fortunately, the improving profits give the company a forward price-to-earnings (P/E) ratio of 22, a reasonable level considering the price. Moreover, the price-to-sales (P/S) ratio now stands at 6.

That is not a record low, as the stock has rebounded nearly 50% from its December trough. Nonetheless, it is a vast improvement from late 2021, when the P/S ratio briefly exceeded 30. When compared to that earlier history, DigitalOcean stock appears reasonably valued.

Reason to sell: Competition

For all of its attributes, DigitalOcean's size is a tiny fraction of its peers'. Its $3.5 billion market cap pales in comparison to competitors whose market caps are near or well above $1 trillion. And assuming some of these small and medium-sized businesses grow into large ones, would they stay with DigitalOcean or switch to a more established, full-service provider?

Still, investors should remember that competitors would have to make changes to compete for DigitalOcean's customers. For one, they would have to offer the same transparent pricing model provided by DigitalOcean. A peer can probably copy that model with relative ease, though it risks losing revenue if its existing clients use the a la carte pricing to drop services.

Additionally, competing with the DigitalOcean Community might be more of a challenge. While AWS, Azure, and others possess the resources needed to solve almost any cloud or IT-related problem, DigitalOcean takes a lower-cost approach by tapping into its community. This would force peers to offer such services for free, likely reducing their revenues.

Consider DigitalOcean

Ultimately, DigitalOcean will likely remain a buy as it retains control of its niche serving smaller businesses. Indeed, a large player could try to copy its model. However, both the pricing model and the possible alternatives to DigitalOcean's Community could prompt current customers to seek cheaper service offerings, thus lowering cloud revenue for peers. Given the cost of lost revenue for such a strategy, it is unlikely competitors will take such an approach.

It is less clear if DigitalOcean can hang on to customers who become large businesses. Nonetheless, as long as it can hold on to its niche, the company and the SaaS stock should prosper long term.