While the broader markets are trading near all-time highs, the recent rally has been primarily driven by big tech stocks that are part of the AI megatrend. This indicates that several other stocks across sectors are trading below all-time highs, allowing investors to buy the dip and potentially benefit from outsized gains when the economy improves. One such growth stock that seems compelling is Datadog (NASDAQ:DDOG), which is down 34% from its all-time high.
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I am bullish on Datadog due to the company’s widening customer base, increasing customer spending, and strong profit margin growth. Valued at $44 billion, Datadog stock priced its IPO (initial public offering) at $27 per share in September 2019. After soaring 39% in its market debut, it touched all-time highs during the bull run in 2021. Today, DDOG stock is priced at $131, much higher than its IPO price.
An Overview of Datadog
Founded in 2010, Datadog is a SaaS (software-as-a-service) company that offers enterprises a platform to ensure their infrastructure applications are running optimally. Its software platform can track performance for systems running on public cloud networks and data centers.
Basically, Datadog offers an observability and security platform for cloud applications that integrates and automates processes such as infrastructure monitoring, application performance monitoring, and cloud security, among others.
Enterprises across industries use Datadog’s services to enable digital transportation and cloud migration and drive collaboration across verticals.
A Massive Opportunity for Datadog
Investors should consider buying shares of companies that are part of expanding addressable markets. Ideally, the company should gain market share in core segments, which would translate to revenue and earnings growth, as well as share price appreciation.
Datadog expects cloud spending to proliferate and account for almost 20% of global IT spending in 2027, up from less than 10% in 2023.
A research report from Gartner (NYSE:IT) estimates the public cloud services market at $560 billion in 2023 and expects it to further expand by 20% annually through 2027. More specifically, Gartner estimates the observability market at $51 billion, which is forecast to grow at a compound annual growth rate (CAGR) of 11% through 2027. Finally, the cloud security market is valued at $21 billion and is expected to expand by 16% annually through 2027.
Datadog is positioned to increase revenue at an attractive pace going forward, given that its sales in the last year totaled “just” $2.258 billion. Further, Gartner identifies Datadog as a leader in its Magic Quadrant for Application Performance Monitoring and Observability.
DDOG’s Expanding Customer Base
A key revenue driver for SaaS companies is their ability to acquire customers and increase customer spending over time. Datadog ended Q1 of 2024 with 28,000 customers, up from 10,536 in the same period in 2019. The number of customers with annual recurring revenue or ARR of more than $1 million increased from 54 in 2019 to 396 in 2023.
Around 47% of customers use four or more products in Q1, up from 35% in 2022, while 10% use more than eight products, up from just 2% in 2022.
Datadog’s robust customer acquisition and retention rates meant it reported revenue of $611 million in Q1 of 2024, an increase of 27% year-over-year. Additionally, its net retention rate is above 110%, which suggests that existing customers increased spending by at least 10% in the last 12 months.
A Focus on Profitability
Similar to other asset-light tech companies, Datadog benefits from high operating leverage. This means the company’s profit margins increase at a faster pace than sales. In the last 12 months, Datadog’s gross margin stood at 83%, up from 76% in 2019. Its operating expenses as a percentage of revenue have fallen from 39% to 23% in this period, allowing it to end the last 12 months with an operating margin of 25%. Comparatively, its operating margin stood at just 11% in 2020.
Further, Datadog’s free cash flow increased to $668 million in the last year, up from $83 million in 2020. Thus, its free cash flow margin improved from 14% to 30% in this period.
A positive free cash flow margin allows Datadog to reinvest in growth projects and target accretive acquisitions without raising additional capital. An increase in profitability also enables Datadog to invest heavily in research and development, which should help it fight off competition from peers and maintain or grow its market share.
Is Datadog Stock a Buy, According to Analysts?
Of the 31 analyst ratings given to DDOG stock, 24 are Buys, six are Holds, and one is a Sell, indicating a Moderate Buy consensus rating. The average DDOG stock price target is $145.67, indicating upside potential of 10.5% from current levels.
The Takeaway
Datadog is among the fastest-growing technology stocks in 2024. Its SaaS-based business model generates steady cash flows across business cycles due to a predictable stream of recurring revenue. Plus, a widening free cash flow margin also gives Datadog enough flexibility to gain traction in multiple expanding markets in the upcoming decade. These factors make the stock worthy of consideration.
