What happened
Shares of Datadog (DDOG +0.59%) tumbled 17.3% last month, according to S&P Global Market Intelligence. On Aug. 8, the observability and application performance monitoring specialist reported second-quarter earnings that exceeded Wall Street's forecasts, but investors were discouraged by management's outlook.
So what
Datadog has been a rock star among growth stocks over the past few years, achieving one of the most impressive revenue growth rates in the market. Software and data monitoring products have experienced strong demand from clients seeking to maximize the performance of their cloud applications, and Datadog is one of the industry leaders in terms of product quality and reputation.
Image source: Getty Images.
However, investors are feeling less bullish about that narrative after another quarter of slowing growth. Datadog reported 25% year-over-year revenue growth in Q2, and it beat analysts' consensus estimates. That's still an impressive rate of expansion, but the trend is clearly slowing. Management revised its full-year forecast downward, confirming that a near-term acceleration is unlikely. Investors were unimpressed with that outlook.
DDOG Revenue (Quarterly YoY Growth) data by YCharts.
This has been a common theme for high-growth software providers over the past year. Macroeconomic pressures and fears have led many large enterprises to cut expenses, and as they have increased the level of scrutiny they apply to new deals, they have extended the length of the sales cycle. Datadog and many of its peers have seen their growth rates tumble as a result, and their previous lofty valuations became unsustainable. Datadog's price-to-sales and forward price-to-earnings ratios have tumbled since the start of 2022, but both valuations are still high enough to expose the stock to volatility whenever the company's growth narrative is threatened.
DDOG PS Ratio data by YCharts.
Now what
Datadog is in a strange spot. A number of issues are likely to impact its earnings over the next few quarters, however, and the stock could be hit hard if there's a market downturn amid ongoing economic uncertainty. There's certainly a chance that its revenue will accelerate when the economic cycle shifts back into expansion mode. However, recent performance issues have called the company's economic moat into question.
Nonetheless, Datadog remains a leader in a high-growth industry, so it should have solid demand catalysts for the medium term. Despite some of the struggles that caught investor attention last quarter, the company still produced nearly $150 million in free cash flow. The latest sell-off hasn't made the stock cheap, but it has created a more attractive entry point for long-term investors.
