Datadog Stock: Strong Growth, Strong Valuation (NASDAQ: DDOG)

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Introduction

Datadog, Inc. (NASDAQ: DDOG) has fallen more than 29% since the start of 2022 as investors shift away from growth stocks. Its shares remain attractive to risk-tolerant long-term investors because its fundamentals are sound – it remains a market leader in a rapidly growing market. However, more risk-averse investors should continue to monitor the stock for better buying opportunities, as the company is still valued at a high premium in an uncertain market.

Datadog is a leader in a growing market

Datadog is one of the easiest and most reliable platforms to use, offering an API interface that allows businesses to observe and capture metrics using client libraries. Datadog offers a new level of collaboration that unites a community of workers, allowing people to annotate and share their thoughts using their platform. Additionally, while Datadog’s competitors struggle to integrate more than two types of monitoring, DataDog finds a way to unify three at once, combining the three pillars of observability. So it’s no surprise that 35% of Fortune 100 companies use Datadog.

Currently, Datadog is a leader in the APM (Application Performance Management) market, growing to a CAGR of 11.4% to 12 billion by 2026. In early 2022, Gardner released a report estimating that the broader IT operations management market will be worth 53 billion dollars in 2025. According to its analysts, “more than 85% of organizations will not be able to fully execute their digital strategies without the use of cloud-native architectures and technologies”. And as a result, they predict that more than half of enterprise IT spending will shift to the cloud.

Solid profits

In the second quarter of 2022, Datadog reported revenue of $406.14 million, representing growth of approximately 73.9% year-on-year. Datadog also reported EPS of $0.24, beating estimates of $0.09. Despite the macroeconomic environment, management estimates its revenue to be between $1.61 billion and $1.63 billion, which means an increase of 56% to 58% compared to fiscal 2021. The company will also be significantly more profitable, with an estimated EPS of between 67% and 237% from fiscal 2021.

Growth remains strong

Datadog’s investments in growth are paying off. The number of its customers increased by 30%, from 16,400 to 21,200. Of these 21,200 customers, more than 2,000 produce an ARR of more than $100,000, which increased by 54.2% year-on-year . Not only did Datadog do a great job of scaling its business, but it also continued to innovate, giving its customers more services to choose from. These investments are paying off. Specifically, in the second quarter, customers using 2 or more of their products increased by 4%, and customers using four or more products increased by 9%. These constant innovations and products will continue to set Datadog apart from the competition and maintain user loyalty. To substantiate this, management stated in its Q2 appeal that “retention was over 130% for the 20th consecutive quarter.”

Risks

One of the main issues that worries investors is the company’s expenses. R&D expenses increased 87% to $174.87 million and sales and marketing expenses increased 41% to $114.67 million. In the current macroeconomic environment, management has not been adamant about cost reduction and is continuing its growth trajectory.

Finally, its financial director David Obstler has sold a large number of shares in recent weeks. This could signal that the stock is currently overvalued.

Datadog Insider Selling

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Evaluation

To value Datadog, I wanted a method that would capture all of Datadog’s growth while remaining conservative. To do this, I first attempted to calculate Datadog’s market capitalization in 2026. If they maintain their current market share of 6.48% in an estimated market of $53 billion, that gives them $3.439 billion. dollars in revenue in 2026. Using the average software P/S ratio of 16.25x (down from its current 27.81x) gives it a market cap of $55.88 billion. Discounting it using a 10% discount rate, this leaves the target market cap at $38.169 billion, an increase of 4%.

Although some may argue that my method is too conservative, it still demonstrates that investors will have a small margin of safety even in a bullish scenario.

Conclusion

Datadog is a growing company and stands out from the competition. However, more cautious investors should steer clear of the stock as it trades at a steep premium. Datadog is definitely a high risk game to reward that isn’t for everyone. However, investors should still keep Datadog on their watch list as insider selling could prevail to “buy the dip” opportunities later in the year.

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