Datadog (DDOG 4.95%) stock had an incredible day on Nov. 7 after it reported third-quarter earnings. The stock was up a little over 30% at its peak and ended the day up a still shocking 28% or so.
As an investor, it is wonderful to see such massive gains, but that kind of volatility can go both ways. So you need to step back and ask yourself if a big daily stock advance is underpinned by reality or just an overly emotional Wall Street.
Datadog rocked the quarter
Giving credit where credit is due, Datadog's third-quarter results were quite strong. Revenue reached $547.5 million, a huge 25% year-over-year increase. Analysts had been expecting a touch over $524 million.
Image source: Getty Images.
On the bottom line, Wall Street analysts expected adjusted earnings of $0.34 per share. But the cloud monitoring, analytics, and security company came in with adjusted earnings of $0.45 per share. A 20% increase in high-value customers (those that spend over $100,000 per year) was a highlight from the quarter.
Adding to the excitement, management increased its full-year guidance for revenue and adjusted earnings. Sales are now projected to be a little over $2.1 billion, up from previous guidance of around $2.05 billion.
Adjusted earnings for all of 2023 are now expected to be between $1.52 and $1.54 per share, up from previous guidance of $1.30 and $1.34. While the updated revenue guidance isn't a gigantic shift, the bottom line guidance changed materially.
So there were some solid reasons for the big stock price advance, but it very quickly priced in a lot of good news. How does that play into the bigger story?
Datadog is a long-term growth story, not a one-quarter growth story
While the one-day advance based on a single good quarter was probably a welcome surprise for investors, you need to step back and think about what really happened. Simply put, Mr. Market got very exuberant very quickly. But why?
The obvious reason is that Datadog beat consensus estimates and raised its full-year guidance. However, the cloud sector has been in a bit of a funk since hitting a recent high-water mark in the second half of 2021.
Datadog's stock, meanwhile, lagged the broader cloud sector, using the Global X Cloud Computing ETF as a proxy. The big daily price jump, which shows up at the tail end of the graph below, is at least partly related to closing that performance gap.
DDOG data by YCharts; ETF = exchange-traded fund.
This isn't just a story of Datadog performing well. It seems likely that investors are reassessing just how negative they were on the company. The swift price jump suggests that the strong performance convinced Wall Street that the company's long-term outlook is rosier than many believed.
Which brings up the stock's lofty valuation. The price-to-sales (P/S) ratio is around 17. That's historically low for Datadog, but compared to some of the technology industry's biggest names, it is still quite high. This means investors are already pricing in a lot of growth ahead.
DDOG PS ratio data by YCharts.
If you have a value bent, Datadog probably isn't the stock for you. And even if you think the company has a bright future, you need to make sure you have a strong conviction backing that belief, given the lofty P/S ratio.
Clearly, the strong third quarter hints that there is a growth opportunity here, but after the shocking one-day price advance, you should probably step back and consider your investment thesis again.
There's no need to do anything
Just because a stock you own has a huge one-day gain doesn't mean you have to make any changes to your portfolio. You can't control big daily stock gains, but you do get to control what you do about them.
In the case of Datadog, you should probably revisit your reasons for owning the stock, given that a nearly 30% price advance discounts a lot of future good news. However, you might actually find that you are more excited now than you were before the strong third-quarter earnings release and guidance update.
