The Nasdaq-100 technology index plunged 33% in 2022, but historical data going back to its inception in 1986 suggests it rarely falls two years in a row. In fact, it only happened on one occasion and that was during the dot-com tech bust from 2000 to 2002. True to form, the Nasdaq-100 bounced back this year with a gain of 43% so far.
Even better, history also points to a strong 2024, because the index has always followed through with a positive return in the year after its initial rebound. While it's unlikely investors will experience a gain as large as 2023's, the data suggests investors can still look forward to an upside of 21% next year (if history repeats). Buying quality tech stocks at a great price right now might be a prudent move.
DigitalOcean (DOCN 3.30%) stock is trading near its 52-week low despite a strong bounce after reporting its financial results for the third quarter of 2023. Here's why this cloud stock is exactly the buying opportunity investors should be looking for ahead of further gains in the broader market.
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DigitalOcean is an on-ramp into the cloud for small businesses
Cloud computing is proving to be a revolutionary technology. It allows businesses to run their operations and their sales channels online, which helps them manage a global workforce and reach customers all over the world. The cloud industry is dominated by Amazon Web Services, Microsoft Azure, and Alphabet's Google Cloud, all of which are backed by their trillion-dollar parent companies.
DigitalOcean, on the other hand, is a stand-alone provider of cloud services and it's valued at just $2.1 billion. In other words, it's completely outgunned by those cloud giants with very limited ability to compete directly. Instead, DigitalOcean targets small to midsize businesses from the start-up phase to those with 500 employees, which is a segment the larger providers tend to ignore.
The company offers those customers cheap pricing, a high level of personalized service, and a simpler platform designed for businesses with little or no tech support staffing. DigitalOcean's business model looks like an enormous funnel, with its 633,000 customers broken into three main categories:
- Learners: 479,000 customers
- Builders: 138,000 customers
- Scalers: 16,000 customers
Learners spend an average of just $15 per month with DigitalOcean. A portion of them eventually graduate to become builders, with an average monthly spend of $136. An even smaller number experience tremendous success and become scalers, spending an average of $1,979 per month.
Scalers account for 54% of DigitalOcean's monthly revenue, so they are the most important group. The good news is that during the recent third quarter, the company added scalers at a faster rate than the other two cohorts.
DigitalOcean just entered the artificial intelligence race
Artificial intelligence (AI) is an area of intense focus for the leaders of the cloud industry. They are racing to build AI-enabled data centers and provide a variety of AI models for their customers to build upon.
In July, DigitalOcean acquired AI cloud provider PaperSpace for $111 million. The two companies are a great match because PaperSpace is also focused on delivering cost-effective services (over 500,000 small enterprises use its services). In fact, it offers cloud infrastructure powered by Nvidia's leading AI chips, yet its pricing is up to 70% cheaper than Microsoft Azure, for example.
It offers per-second billing with no lock-in contracts, which is an ideal combination for start-ups and small businesses looking to develop AI. Plus, because PaperSpace is focused solely on AI cloud services, its costs are streamlined, which keeps prices low.
This acquisition could make DigitalOcean a go-to destination for the next generation of leading AI start-ups looking to develop the technology with limited financial resources. Plus, it could also help more of DigitalOcean's learners and builders graduate to scalers, which would be a big revenue boost for the company over the long term.
Why DigitalOcean stock is a buy now
DigitalOcean impressed investors with its third-quarter financial results, and they sent its stock surging by 25%. But it was at a 52-week low right before the jump, and it's still trading in the red for 2023 despite the strong gain in the Nasdaq-100.
DigitalOcean's Q3 revenue came in at $177.1 million, representing year-over-year growth of just 16%, which was less than half the growth rate it delivered in the third quarter of 2022. But there were two silver linings. First, the result was above the company's prior forecast, and second, it prompted management to lift its full-year guidance for 2023 by $5 million, to $690 million.
Furthermore, the slowdown in growth is partly due to careful expense management. DigitalOcean's marketing spending in Q3, for example, was flat compared to the same time last year. Its general and admin costs fell by almost half. That allowed more money to flow to the bottom line as profit, sending the company's net income surging by 142% to $19.1 million.
Simply put, DigitalOcean has swapped a fast-growing but loss-making business for one with steady growth and healthy profits. But with its expanding initiatives in the AI space, the company might soon find an acceleration in growth once again while maintaining a healthy bottom line.
As a result, 2024 looks bright and this could be a great stock to own especially if history repeats for the broader market.
