Better AI Stock: Roblox vs. DigitalOcean

Roblox (RBLX 1.35%) and DigitalOcean (DOCN 3.30%) operate in completely different markets. Roblox enables its users to create games with a simple block-based system, share them with other users, and then monetize them to earn an in-game currency called Robux. DigitalOcean provides cloud-based infrastructure services to smaller companies through tiny "droplets" of servers, which are generally cheaper and easier to access than larger cloud platforms.

Yet, both of these growing companies are expanding into the nascent artificial intelligence (AI) market. Roblox just launched the beta versions of two new generative AI game creation tools -- Code Assist for generating code through natural conversations and Material Generator for creating material designs by simply describing them -- to make creating games easier.

DigitalOcean just acquired Paperspace, another small cloud infrastructure platform provider that equips its servers with high-end graphics processing units (GPUs) for processing AI tasks. It enables smaller businesses to test and scale their AI services on its cloud.

Image source: Getty Images.

Both moves seem like smart ways to capitalize on the expansion of the generative AI market, which Valuates Reports estimates will grow at a dizzying compound annual growth rate (CAGR) of 32% from 2022 to 2031. But will Roblox or DigitalOcean be a better long-term play on that secular trend?

Roblox's growth metrics are improving

Roblox's growth accelerated during the pandemic as students stayed home and spent more time creating and playing its games. However, that growth spurt ended as the pandemic passed and its core audience of tween users returned to school.

Roblox's bookings soared 45% in 2021 but only grew 5% to $2.9 billion in 2022 as the pandemic-induced tailwinds dissipated. It also increasingly relied on lower-margin overseas and older users to drive its bookings growth, and that pressure caused its net loss to widen from $492 million in 2021 to $924 million in 2022.

But if we look at Roblox's quarterly growth in bookings, daily active users (DAUs), total hours engaged, and average bookings per daily active user (ABPDAU), we can spot some clear signs of improvement over the past year.

Data source: Roblox. YOY = Year over year.

Roblox's DAUs reached 66.1 million in the first quarter of 2023, while its declining ABPDAU -- which was largely caused by its expansion into overseas markets with lower average bookings per user -- seemed to finally bottom out. Rolling out new generative AI tools for its platform could help it attract new creators or convince its existing players to create and monetize their own games.

For 2023, analysts expect its bookings to grow 19% to $3.4 billion -- but its net loss could still widen to $1.1 billion. Therefore, Roblox hasn't proven that its business model -- which mainly relies on Robux sales -- is actually sustainable. Its stock has already pulled back from its all-time highs, but it still isn't cheap at 8 times this year's bookings.

DigitalOcean is still growing in a tough macro environment

When DigitalOcean went public in March 2021, the critics claimed it would struggle to compete against larger cloud infrastructure platforms like Amazon Web Services (AWS) and Microsoft Azure. They also warned that DigitalOcean didn't have sufficient scale to survive in that crowded market.

Yet, DigitalOcean's revenue rose 35% in 2021 and grew 34% to $576 million in 2022. Its growth in builders and scalers (customers who spend at least $50 a month), average revenues per user (ARPU), and net dollar retention rate (NDR, or year-over-year revenue growth per existing customer) all kept rising over the past year -- even as the macro headwinds caused noticeable problems for AWS and Azure. It expects its revenue to rise another 22% to 25% this year.

Data source: DigitalOcean.

Moreover, its adjusted gross, operating, earnings before interest, taxes, depreciation, and amortization (EBITDA), and free cash flow (FCF) margins have all been expanding over the past year. That expansion indicates it still has plenty of pricing power in its niche cloud market -- and analysts expect it to turn profitable this year as economies of scale finally kick in.

DigitalOcean's recent acquisition of Paperspace could accelerate that transformation, lock in its existing customers with more AI-oriented features, and keep pace with the bigger cloud platforms as the broader AI market expands. DigitalOcean's stock isn't cheap at 7 times this year's sales, but its dominance over its niche market might justify that premium.

The better buy: DigitalOcean

Both of these stocks are speculative, but DigitalOcean's stronger growth, clearer focus, rising profits, and slightly lower valuations make it a better buy right now. Roblox might keep growing, but it still needs to meaningfully narrow its net losses to be considered a safe long-term investment.