Although it used to be a popular pick in the software-as-a-service space, Datadog's (DDOG 4.95%) popularity has taken a back seat to companies focused on artificial intelligence (AI). While Datadog has some AI characteristics built into its platform, it's not devoted to the technology.
However, not being involved in the AI hype wave is actually a bonus for prospective and current shareholders as it allows investors to accurately assess the company from a more neutral standpoint. So with that in mind, is Datadog stock set for a breakout? Read on to find out.
Its products solve a headache-level problem
Datadog's primary mission is to ensure all of a client's techn stacks integrate properly. In a modern business, multiple data streams are feeding various cloud or on-premise programs, and detecting when there is an issue with data flow can be problematic as it can be days before anyone realizes something was broken. Additionally, these data streams can be subject to cyber attacks, and protecting proprietary information is a huge challenge in today's digital environment.
Datadog's products help solve this problem as the software gives its users unparalleled visibility into how an app is performing. Additionally, it can fix issues before they become a problem, which prevents costly downtime. Finally, its security product line allows tech teams to detect threats and protect infrastructure before significant damage can occur.
This product lineup has proven wildly successful, and Datadog's revenue has nearly quadrupled in just three years. However, that growth is starting to fade, causing investors to worry about Datadog's future.
Revenue growth is quickly slowing down
In the first quarter, Datadog grew its revenue by 33% to $482 million. While 33% may sound impressive, it's the lowest quarterly revenue growth figure that the company has reported as a public company.
DDOG Revenue (Quarterly YoY Growth) data by YCharts
Second-quarter guidance didn't do anything to soothe these worries as Datadog has projected revenue growth of 23%.
Management points to clients "optimizing" their cloud usage as the key catalyst for Datadog's slowdown. While the company doesn't know when this trend will end, it expressed confidence in its Q1 conference call that it should be soon. Datadog remains confident in its long-term goals and isn't changing anything to meet the current market conditions.
This move will either be applauded or seen as a huge red flag, depending on what happens over the next three to five years. Unfortunately, no one knows if cloud spending will return once the economy kicks back into gear. However, I think the trend is toward a cloud-based computing system, and Datadog's products will be needed to bridge the gap between offerings from multiple companies.
The stock isn't cheap
With all this in mind, does Datadog trade at a fair price? Fortunately, the company isn't massively unprofitable. In Q1, it only lost $24 million compared to $482 million in revenue. Although this caused Datadog to lose its year-over-year profitability status, it's not a deep hole from which to emerge.
Still, we must value the company from an alternative method besides earnings per share because the company is just barely turning profitable, so the metric looks skewed. Free cash flow is a great metric for companies just achieving profitability as it values the business from its ability to generate cash.
At 90 times free cash flow, Datadog isn't anywhere near cheap.
DDOG Price to Free Cash Flow data by YCharts
From a price-to-sales standpoint, Datadog's stock is also expensive.
DDOG PS Ratio data by YCharts
No matter how you look at it, Datadog's stock is far from cheap. So does that mean investors should avoid it? I don't think so. The company plays an important role in the cloud infrastructure. But because the stock is expensive, I'd caution investors not to let it make up more than 2% of their portfolio; that way, if its valuation declines, it doesn't hurt too much.
The three- to five-year upside for Datadog is there, but with the uncertainty of the cloud computing market in the short term, investors need to be prepared for a bumpy ride.
