At first glance, Datadog (NASDAQ:DDOG) is the kind of stock that you’d think would be down even more in the current market. The investor-favorite tech stock commanded rich valuations last year and still arguably trades with rich valuations, even as much of the tech sector undergoes severe multiple contraction. Yet for all the potential reasons for greater weakness there are as many reasons for the resilient strength: this is a company which continues to beat-and-raise on revenue guidance, all while generating positive free cash flow. In this article I discuss four questions to ask before considering DDOG as an investment.
DDOG Stock Price
DDOG is trading around $110 per share – around 45% lower than all time highs achieved just half a year ago.
Considering that this was a stock trading at around 45x sales at the peaks, it may surprise some to see that the stock has fallen “only” 45%. I last covered the stock in February when I noted that the stock was still richly valued as compared to peers, and it has since fallen another 30%. While that statement is still true, the stock has finally come down to buyable levels.
DDOG Stock Key Metrics
In the latest quarter, DDOG delivered $363 million in revenue, comfortably beating guidance of up to $339 million and growing 83% year over year.
DDOG has sustained net retention rates in excess of 130% for 19 straight quarters, and this shows in the consistent growth in customers using multiple products.
DDOG has also sustained impressive growth in total customer count.
We can see a breakdown of their margin profile below – the company has sustained impressive free cash flow margins. I note that free cash flow does include deferred revenue, so investors may want to place more emphasis on non-GAAP operating profits to better understand free cash flow on a sustainable level.
Looking forward, DDOG has guided for up to $380 million in revenue, representing 62% year over year growth. But that looks very conservative considering the company’s track record of delivering beats on earnings.
What is Datadog?
The first and most critical question to understand when buying any investment is to understand the business model. DDOG is an enterprise tech company in the observability space, which means that it helps companies extract value from their data.
We can see how DDOG’s product offerings developed over time below:
Some typical examples of the value that DDOG provides to its customers include alerting customers of any failures or anomalies in technological workflows, as well as giving customers the ability to decide which data is indexed or stored simply. DDOG represents one of the top companies in the data sector, making it easy to resonate with the broad investor base.
Is Datadog Undervalued?
Wall Street analysts seem to think so. The average rating is 4.2 out of 5.
The average price target of $178.62 per share represents just over 60% upside.
I’ll discuss the valuation a bit more down below, but I note that in the current environment, DDOG does trade more richly than most peers as it is still commanding a 32x trailing sales multiple.
Is Datadog Profitable?
One appealing factor of DDOG is that it is profitable – a seeming rarity in the tech sector. Not only is DDOG generating some GAAP profits, but it is also generating substantial income on a non-GAAP basis.
Sure, the main non-GAAP adjustment is stock-based compensation, which is a controversial adjustment considering that it does negatively impact shares outstanding. However, the non-GAAP operating income does reflect real cash flow and is an indication that the company has limited financial risk due to the robust free cash flows.
Is Datadog A Good Long-Term Investment?
Over the next nine years, analysts expect growth to gradually decelerate after 57% growth this year.
I do expect DDOG to materially outperform its $1.62 billion guidance, though consensus estimates do look reasonable as one should expect retention rates to eventually dip below 130% as it succeeds in cross-selling its customers multiple products. I could see DDOG generating at least 30% net margins over the long term. Using a 1.5x price to earnings growth ratio, DDOG might trade at 9x sales by 2030, representing a stock price of $337 per share and 13% compounded annual returns. Yet this is a name that may even generate 40% long term net margins and earn a 2x PEG ratio due to its attractive investment thesis. That would place the stock at 15x sales, or a price of $570 by 2030, representing 20% annual returns over the next nine years. That kind of return potential is attractive considering the clear-cut investment thesis.
DDOG offers a way to invest in the growth of data as its software becomes more and more useful as data inevitably continues to grow. This is a profitable company which has consistently beat already aggressive guidance. Key risks to this thesis include multiple contraction, as the name trades materially higher than other tech peers even on a growth-adjusted basis. Other risks include potential competition, as observability is a big sector and the various competitors are bound to eventually come head to head at some point. At the current moment, DDOG appears quite early in its growth trajectory and the current stock price also appears to offer attractive upside. I rate the stock a buy for those looking for a profitable name in the tech sector.