Datadog (DDOG 4.95%) stock got clobbered after the company released its second-quarter 2023 results on Aug. 8, which wasn't surprising as management delivered soft revenue guidance for the current quarter and also lowered the full-year outlook.
Shares of the company, which provides information technology (IT) monitoring software for cloud applications, crashed 19% in a single session. Investors were quick to press the panic button as Datadog's guidance wasn't solid enough to justify its rich valuation. However, a closer look at Datadog's performance last quarter suggests that the challenges slowing it down are likely to be temporary.
Let's see why Datadog's latest drop looks like a buying opportunity.
Near-term challenges are weighing on Datadog stock
Datadog's Q2 revenue increased 25% year over year to $509.5 million, while adjusted earnings shot up 50% to $0.36 per share. Wall Street would have settled for earnings of $0.28 per share on revenue of $501.6 million, but the healthy growth in the company's customer base as well as an increase in spending by existing customers helped it easily clear those estimates.
More specifically, Datadog's customer count increased 23% year over year in Q2 to 26,100. The number of large customers with at least $100,000 in annual recurring revenue (ARR) also increased 23% to almost 3,000 during the quarter. Another solid takeaway from Datadog's latest quarterly results was that its customer base is adopting more of its solutions.
For instance, the number of customers using six or more products from Datadog stood at 21% in the previous quarter, up from 14% in the year-ago period. The percentage of customers using four or more products from the company increased to 45% in Q2 from 37% in the year-ago period.
All this indicates why Datadog's dollar-based net retention rate stood at more than 120% last quarter. This metric compares the revenue from Datadog's customer cohort in a period to the revenue from the same customer cohort in the year-ago period. So, a reading of more than 100% means that Datadog's customers have increased their spending on the company's solutions.
However, the company has warned that it is witnessing a pullback in spending by some of its large customers. On the latest earnings conference call, CEO Olivier Pomel said:
Going one level deeper, in Q2, we saw usage growth for existing customers that was a bit lower than it had been in previous quarters. We continue to see customers, particularly some larger spending customers, scrutinize costs and optimize their cloud and observability usage during Q2.
As a result, Datadog's guidance for the current quarter wasn't up to the mark. The company anticipates $523 million in revenue in the third quarter at the midpoint of its guidance range, while non-GAAP earnings are expected to land at $0.34 per share. Those numbers point toward a 22% year-over-year jump in the company's top line and a 48% jump in earnings. Wall Street was anticipating $536 million in revenue from Datadog in the current quarter.
Also, Datadog has lowered its full-year revenue outlook to $2.05 billion from its earlier expectation of $2.09 billion. The updated revenue guidance suggests that its top line is on track to increase 22% this year. That would be a major slowdown over 2022, when Datadog's revenue had shot up a handsome 63% to $1.68 billion.
For a stock that's trading at a rich 15 times sales, the sharp slowdown in Datadog's growth this year explains why the stock fell after its latest report. But investors looking to buy a growth stock may want to take a closer look at Datadog since the company believes that things are about to get better, and the huge end-market opportunity that it is sitting on should power its growth in the long run.
A look at the bigger picture
Datadog pointed out on the earnings call that it has started witnessing a rebound in the usage of its platform by existing customers. So, the slowdown in the company's business is likely to be temporary. That isn't surprising, as the growing adoption of cloud computing is going to be a secular tailwind for its business, driving a greater need for its cloud observability and security solutions.
Datadog estimates that spending on cloud computing as a percentage of global IT spending could rise from 10% in 2022 to 17% in 2026. With global IT spending expected to jump to $1 trillion in 2026 from $500 billion last year, the company expects its addressable market to grow at a nice clip. More specifically, Datadog sees its total addressable market (TAM) jumping to $62 billion in 2026 from $41 billion last year.
The company's full-year revenue forecast indicates that it still has a lot of room to grow given the TAM that's expected. Not surprisingly, Datadog's growth is expected to accelerate from next year.
DDOG Revenue Estimates for Next Fiscal Year data by YCharts
It may be a good idea for investors to take advantage of the dip in Datadog stock as it is trading at a relatively cheaper level now than it was a year ago.
DDOG Revenue (TTM) data by YCharts
The chart above shows that Datadog's revenue has increased at a robust pace in the past year, but its price-to-sales ratio has gone down. So, investors are getting a relatively good deal on this cloud stock now, and capitalizing on this opportunity could turn out to be a smart long-term move.
