Shares of Datadog (DDOG +9.46%) slumped 11% in July, according to data from S&P Global Market Intelligence. The stock struggled with difficult market conditions related to a surprise global IT outage that weighed on tech stocks. Investor risk tolerance is declining because of a cloudy macroeconomic outlook, causing some people to rethink aggressive valuations on growth stocks. Reports of a transformative acquisition in the works contributed to the uncertainty in the weeks leading up to August's quarterly financial report.
DataDog was a victim of a larger market trend
Datadog took a big step lower along with most other tech stocks halfway through July. A faulty software update from CrowdStrike (CRWD +3.21%) caused computer crashes all over the world for computers running Microsoft's (MSFT +4.64%) operating system. Valuations have surged for many tech stocks thanks to renewed optimism about short-term economic recovery and long-term prospects for AI. Aggressive valuations opened the door to volatility, and the global IT outage pushed many sensitive investors toward the exit.
IMAGE SOURCE: GETTY IMAGES.
That move weighed on Datadog stock. Its price chart was remarkably similar to the ProShares Ultra QQQ ETF (QLD +2.63%), which seeks to double the daily return of the Nasdaq Composite.
DDOG Total Return Level data by YCharts
Obviously, Datadog stock performed even worse than the ProShares Ultra QQQ ETF, which is already an exaggerated version of the large-cap tech index. Clearly, something else was at play.
Uncertainty, rumors, and an expensive valuation
Datadog shares tumbled, even though forecasts for its future revenue and profits were essentially unchanged. Consensus estimates for 2024 and 2025 barely changed. The move lower was only down to momentum and investor risk tolerance.
DDOG EPS Estimates for Next Fiscal Year data by YCharts
The biggest headlines on Datadog were related to reported interest in acquiring GitLab (GTLB +8.32%). Sources say that Gitlab hired investment bankers to manage the process, which indicates that they are serious about executing the sale. It also increases the likelihood that multiple credible bidders come to the table, which drives up the price.
Datadog doesn't have enough cash on its balance sheet to execute a cash transaction, so the company needs to issue debt or new shares. Moreover, GitLab has higher forward P/E and price-to-cash-flow ratios than Datadog, so the value attached to the acquired cash flows will likely fall once they change hands. It will take time and execution to close the gap.
DDOG PE Ratio (Forward) data by YCharts
The combination of services makes sense on paper, but it's an expensive gamble. Investors aren't excited about uncertainty under the current circumstances. Datadog's forward P/E ratio is nearly 70 heading into its quarterly earnings report, implying that investors expect it to maintain its recent revenue growth rate, which has been over 30%.
When risk tolerance is weak, growth stocks tend to struggle on any major headline that isn't firmly positive. Look for DataDog's forward commentary in its next quarterly report to either reverse or extend the macro-driven trends that dominated in July.
