Software developer Datadog (DDOG) is joining an exclusive club. Last week, it was announced that the stock will be included in the S&P 500 Index (SPX), sending its price near 52-week highs on significant volume.
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A closer look reveals a lot to like about Datadog, which is making Wall Street swoon. On the other hand, there are also reasons for caution (e.g., premium valuation, competition, macroeconomic vulnerabilities). This dynamic leaves me Neutral on Datadog’s stock, especially once the excitement subsides following its inclusion in the S&P 500.
Unpacking Institutional Demand and the ‘Index Effect’
Datadog’s upcoming inclusion in the S&P 500, effective July 9, carries meaningful implications. First and foremost, it reflects a strong endorsement of the company’s business model and financial stability, given the S&P committee’s stringent selection criteria. Datadog will replace Juniper Networks (JNPR), which is being acquired by Hewlett-Packard Enterprise (HPE).
Following the announcement, Datadog shares surged 12% as investors anticipated the so-called “index effect”—a phenomenon where demand increases due to purchases by passive index funds and ETFs. Because every investment in the S&P 500 includes a proportional allocation to its constituents, Datadog—now with a market cap exceeding $53 billion—will comprise roughly 0.1% of the index. While that percentage may seem modest, it becomes significant given the scale and volume of S&P 500-related trading activity.
Datadog’s Financial Strength Creates a SaaS Powerhouse
For those unfamiliar, Datadog provides monitoring and analytics solutions for cloud-scale applications, positioning itself as a strong example of the Software-as-a-Service (SaaS) model. SaaS businesses are typically characterized by high margins, low capital requirements, and predictable, recurring revenue—factors that often support premium valuations. Datadog’s recent inclusion in the S&P 500 further underscores its operational strength and financial momentum.
In the first quarter of 2025, Datadog reported revenue of $762 million, representing 25% year-over-year growth. According to TipRanks data, DDOG also generated $272 million in operating cash flow and $244 million in free cash flow, reflecting disciplined capital management.
Impressively, its operating cash flow margin stood at approximately 33%, more than double the S&P 500 average of 14.9%, showcasing the efficiency and scalability of its SaaS model. The company ended the quarter with $4.4 billion in cash, cash equivalents, and marketable securities, providing a strong foundation for future growth.
AI and Platform Expansion Fuel Future Growth
Like many technology firms, Datadog has increasingly pivoted toward artificial intelligence (AI), offering tools designed to monitor large language models (LLMs) and other AI-driven systems. A key advantage of the SaaS business model is the potential for cross-selling and upselling, encouraging customers to adopt additional products over time.
In Datadog’s case, 83% of customers now use at least two products, while 51% utilize four or more. This multi-product adoption not only deepens customer engagement but also increases switching costs, contributing to lower churn rates. As a result, Datadog demonstrates strong customer retention, with gross revenue retention consistently in the mid-to-high 90% range, underscoring the stickiness and value of its platform.
Navigating Valuation & Competition: A Balancing Act
With Datadog’s stock up 76% over the past three months, its current valuation reflects high investor expectations. The company is trading at a Price-to-Earnings (P/E) ratio of 336.1, significantly above the IT sector median of 30. While this premium is elevated, it is partially justified by Datadog’s strong fundamentals. The company reported year-over-year revenue growth of 25.5%, more than four times the sector median of 6.2%.
Additionally, its trailing twelve-month gross profit margin of 80.1% substantially exceeds the sector average of 50.2%. However, such lofty expectations come with risk. Any misstep or shortfall in performance could lead to a sharp decline in the stock’s value.
Datadog also operates in a highly competitive landscape. It faces not only the native monitoring and observability tools offered by cloud hyperscalers such as Amazon (AMZN), Microsoft Azure (MSFT), and Google Cloud Platform (GOOGL), but also specialized competitors like Zscaler (ZS) and CrowdStrike (CRWD). To sustain its leadership, Datadog will need to continue executing on product innovation and differentiation.
Is Datadog a Buy or Sell?
On Wall Street, DDOG has a “Strong Buy” consensus rating based on 31 Buy, six Hold, and zero Sell ratings in the past three months. Its average price target of $140.46 implies a 9.47% downside potential over the next 12 months.
Recently, analyst Koji Ikeda from Bank of America reiterated a Buy on DDOG and increased its price target from $138 to $150. The analyst highlighted Datadog’s “active involvement in the AI sector, which is expected to drive further revenue growth.” Moreover, “Datadog’s ongoing innovation and new product releases position it well to capitalize on emerging opportunities in the AI space,” the analyst said.
Public Listing Creates High Growth and Higher Expectations
Datadog’s inclusion in the S&P 500 marks the culmination of years of strong execution, positioning the company for additional benefits, such as increased institutional ownership and enhanced visibility. Its strategic expansion into AI and large language model (LLM) monitoring could serve as a meaningful growth driver in the years ahead.
However, the market’s expectations are exceptionally high, and any deviation from projected performance may be met with sharp downside pressure. Given the balance of promising opportunities and elevated valuation risk, I maintain a neutral outlook on DDOG at current levels.