Datadog (DDOG;NASDAQ) $132.98

Market cap: $43.7 billion

Booming spending on AI (artificial intelligence) and cloud computing infrastructure has ignited a new tech bull market. That’s the claim of several analysts and fund managers and if you’re willing to bet on that narrative, Datadog (DDOG:NASDAQ) is a stock worth backing.

While overall IT budgets are expected to be up modestly in 2024, cloud and AI-driven spending will be up 20% to 25% over the next year, ‘with use cases now exploding’ in the enterprise and consumer landscape.

‘We believe the new tech bull market has now begun, and tech stocks are set up for a strong 2024 as the AI spending tidal wave hits the shores of the broader tech sector,’ as one analyst told clients.

Investing in US growth stocks comes with risk. These companies can often be more volatile than average, often look expensive compared to the market, and there’s things like currency unpredictability to consider.

But as we have seen over the past 12 months or so, when stocks like Nvidia (NVDA:NASDAQ), Meta Platforms (META:NASDAQ) and Palo Alto (PANW:NASDAQ) clocked up triple-digit returns, buying well-positioned tech growth stocks can pay-off way more impressively than even the most optimistic predictions.

So, what makes Datadog worth a look? The short answer is that it provides mission-critical data tools to businesses and is rapidly expanding its total addressable market as organisations around the world grapple with the huge volumes of data that AI and machine learning need to become effective.

WHAT DATADOG DOES

Datadog won’t be a familiar name to most UK investors, but we expect that to change over the coming years. The $43.7 billion Manhattan-based business provides a software-as-a-service suite that allows clients to monitor and analyse cloud-scale applications across the technology stack in real-time from a single place. This means monitoring servers, databases, tools, and services across major cloud providers, including Amazon’s (AMZN:NASDAQ) AWS, Microsoft (MSFT:NASDAQ) Azure, Alphabet’s (GOOG:NASDAQ) Google Cloud and others.

This makes Datadog a crucial behind-the-scenes facilitator for more than 25,000 firms worldwide.

‘The company’s unified, real-time view into the entire technology stack remains mission-critical to developers and enterprises as they focus on identifying and eliminating performance issues,’ spelled out analysts at Oppenheimer in a note to clients. ‘While not recession-proof, the mission-critical nature of its solutions gives Datadog relative resiliency in times of spending constraints,’ they said.

Rapidly expanding its target market, through vertical shifts into areas like digital security, corporate compliance, and workflow efficiency, has scope to massively ramp the revenue growth opportunity. BMO analysts earlier this month calculated Datadog’s core TAM (total addressable market) out to 2026 at $24 billion, yet thrown in large adjacent opportunities, BMO projects a 2026 TAM of approximately $58 billion.

To get here, Datadog has had to invest millions of dollars, and shareholders have endured a white-knuckle ride. After clocking up roughly $123 million of net losses in the five years to 2022, results for 2023 should reveal its annual profits breakthrough.

The company reported net earnings per share of $0.28, $0.36, and $0.45 in quarters one to three in 2023, with Q4 (to 31 December) due on 13 February. It calls for around $0.44 of EPS to hit the consensus full year forecast of $1.53, according to Stockopedia data. 2024 consensus is set at $1.82 but we see scope for those estimates to rise as the year progresses, providing more momentum for the share price.  

‘We believe the dynamics of the cloud market have meaningfully improved in the past few quarters, which should help with Datadog’s revenue growth in 2024 and beyond’, said BMO in its initiation note to clients this month.

Oppenheimer has previously noted Datadog’s high-teens percentage free cash flow and operating margins, while growing revenue above 30% a year on average. Datadog has beaten quarterly forecasts every time since it listed on Nasdaq in September 2019 at $27 per share.

WHERE IT COULD GO WRONG

As Datadog continues to integrate itself at the heart of its clients’ operations, it makes the company a potential target for malicious cyber-attacks. A lot of sensitive data and information is flowing through its platform, and if the company were to suffer a significant data breach, it could expose this business to some significant reputational damage.

There is also intense competition in this area, both from in-house tools hosted by the big cloud providers previously mentioned, plus specialists like Dynatrace, New Relic and AppDynamnics, according to Gartner. This means Datadog will have to keep investing in R&D to maintain an edge.

It’s also important to realise that the valuation, while down about a third from pandemic peaks, when the stock hit $193 in October 2021, still trades at lofty multiples – a price to earnings of about 72, on current estimates. That said, great growth stocks never look cheap in the short term, so potential investors must put near-term valuations into the context of long-run growth potential.

All-in-all, Shares believes that Datadog shares offer a rare combination of growth and profit for years into the future and are worth buying now.

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