Shares of Datadog (DDOG 0.34%) have jumped an impressive 36% in the past two months, well beyond the broad recovery stocks have seen as President Trump put a pause on his most aggressive trade policies. As a cloud observability and security solutions provider, the company has been growing at a robust pace thanks to a sizable addressable market and the rapid adoption of artificial intelligence (AI) tools across the economy.
Datadog's platform enables customers to monitor, analyze, and observe the performance of their cloud infrastructure and applications in real time. Customers can prevent potential issues with their IT infrastructure by using real-time data and troubleshooting problems before they worsen.
And now, customers are deploying Datadog's solutions to monitor their cloud-based AI infrastructure, including large language models (LLMs) and generative AI apps, which could unlock a robust growth opportunity for the company. Not surprisingly, analysts are upbeat about Datadog's prospects. But is it a good idea to buy shares of Datadog following its double-digit rally?
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Datadog remains a Wall Street favorite, but there's a catch
Out of 45 analysts covering Datadog stock, 80% recommend buying the stock while the rest have a hold rating. The 12-month average price target of $135 per share also points toward a potential jump of 13% from current levels.
But is that favorable view and price target from Wall Street enough reason to buy the stock? While it may be enough to convince existing shareholders to hold on tight, new investors have to stomach the stock's expensive valuation.
Datadog is trading at a whopping 250 times trailing earnings. The forward earnings multiple of 62 highlights the company's rapid earnings growth, but it's expensive nonetheless. Investors have to pay a premium if they want to buy the stock right now.
That said, Datadog could justify its expensive valuation in the long run thanks to the potential opportunity AI will bring.
AI has the ability to supercharge this company's growth
When Datadog released its first-quarter results last month, it reported solid year-over-year revenue growth of 25%. The company's bottom line was about flat year over year as the company prioritized investments in its sales force and research and development (R&D) to ensure that it makes the most of the lucrative multibillion-dollar end-market opportunity it faces.
Specifically, Datadog's sales rep headcount was up 25% from the year-ago period, while its R&D outlay jumped 30%. Management estimates the company has a $53 billion revenue opportunity in the observability market and a $26 billion addressable market in cloud security, so it's easy to see why the company has been investing aggressively in its technology and sales team. Both markets are also expected to grow at a double-digit annual rate through 2028.
Importantly, Datadog is witnessing rapid adoption of its AI-focused solutions. The company pointed out on its earnings call last month that the number of companies using its LLM observability solution has doubled in just six months. This product allows customers to "manage end-to-end model performance, security and quality."
Meanwhile, the overall demand for Datadog's AI tools has also increased. The company offers solutions such as Bits AI, an AI-enabled assistant that allows users to gain insights from observability data with conversational prompts. Datadog points out that the number of customers who have integrated at least one of its AI tools into their operations doubled last quarter.
The company ended Q1 with a 30,500-strong customer base, of which 4,000 customers are using its AI solutions. That leaves the company with a large cross-selling and upselling opportunity.
Datadog's high valuation will likely keep some investors away, but it's an attractive choice for those looking to buy a growth stock where AI is already shaping up to be a major growth driver for the business.
