piranka
Introduction
Datadog, Inc. (NASDAQ:DDOG) has fallen over 29% since the beginning of 2022 as investors have rotated away from growth stocks. Its shares remain attractive for long-term investors who are risk tolerant as its fundamentals are sound – it remains a market leader in a fast-growing market. However, more risk-averse investors should continue to monitor the stock for better buying opportunities as the company is still being valued at a hefty premium in an uncertain market.
Datadog is a market leader in a growing market
Datadog is one of the easiest and most reliable platforms to use, offering an API interface that allows companies 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. In addition, while competitors of Datadog struggle to integrate more than two kinds of monitoring, DataDog finds a way to unify three at once, combining the three pillars of observability. Therefore, it’s no surprise that 35% of Fortune 100 companies use Datadog.
Currently, Datadog is a market leader in the APM (Application Performance Management) market, growing at a CAGR of 11.4% to 12 billion by 2026. In early 2022, Gardner published a report estimating that the broader IT operations management market will be worth $53 billion in 2025. According to its analysts, “more than 85% of organizations will not be able to fully execute on their digital strategies without the use of cloud-native architectures and technologies.” And as a result, they predict that over half of the enterprise IT spending will be shifted to the cloud.
Strong earnings
In Q2 of 2022, Datadog reported $406.14M in revenue, a growth of about 73.9% YoY. Datadog also reported EPS of $0.24, beating estimates by $0.09. Despite the macroeconomic environment, management estimates its revenue to be between $1.61 billion and $1.63 billion, which means a 56% to 58% increase from FY 2021. The company will also be much more profitable, with EPS estimated to increase between 67% to 237% from FY 2021.
Growth remains strong
Datadog’s investments into growth are paying off. It saw a 30% increase in its customers, growing from 16,400 to 21,200. Of these 21,200 customers, more than 2000 are producing an ARR of over $100,000, which increased 54.2% YoY. Not only has Datadog done an excellent job in scaling their company, they have also continued to innovate, offering their customers more services that they can pick from. These investments are paying off. Specifically, in Q2, customers using 2 or more of their products went up by 4%, and customers using four or more products went up by 9%. These constant innovations and products will continue to distinguish Datadog from the competition and maintain their user retention. To back this up, management reported in their Q2 call that “retention was above 130% for the 20th consecutive quarter.”
Risks
One of the main issues making investors uneasy is the company’s spending. 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 cutting costs and is continuing its growth trajectory.
Finally, its CFO David Obstler has sold a large number of shares in recent weeks. This could signal that the stock is currently overvalued.
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Valuation
To value Datadog, I wanted a method that would capture all of Datadog’s growth while staying cautious. To do this, I first attempted to calculate Datadog’s market capitalization in 2026. If they retain their current 6.48% market share in an estimated market of $53 billion, that gives them $3.439 billion of revenue in 2026. Using the average software P/S ratio of 16.25x (down from its current 27.81x) gives it a market capitalization of $55.88 billion. Discounting it back using a 10% discount rate, that leaves the target market cap at $38.169 Billion, or a 4% upside.
Although some may argue that my method is too conservative, it still demonstrates that investors will have a slim margin of safety even in a bullish scenario.
Conclusion
Datadog is a fast-growing company and differentiates itself from the competition. However, investors who are more cautious should stay away from the stock as it’s trading at a hefty premium. Datadog is definitely a high-risk to reward play that isn’t for everybody. However, investors should still keep Datadog on their watch list as insider selling might prevail to “buy the dip” opportunities further down the year.
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