Buy Datadog Stock Now? Cloud’s Next Chapter Unfolds
Table of contents
Humans have a pretty short memory. So, until we all get chip implants to stave off the worst effects of the impending singularity, we have to rely on old-fashioned research to maintain our historical perspective. For example, did you know that cloud computing – at least in some primitive, Stone Age form – has been around since at least the 1960s? This was before the advent of minicomputers, let alone desktop computers and laptops, so mainframe computers served as the backbone of the early tech-bro era. But only governments and the largest companies (like IBM) could afford to buy and operate these monster machines, according to a history of cloud computing from TechTarget.
A guy named John McCarthy solved the problem through time-sharing via an operating system that enabled multiple users to access the mainframe simultaneously using a dial-up connection. Fast forward through the rise of Amazon Web Services (AWS) and Salesforce with its software-as-a–service (SaaS) business model. Today, cloud services help enterprises juggle everything from hybrid cloud environments to AI workloads and cybersecurity threats – requiring all sorts of ancillary services to make sure all of these computing components are running smoothly.
That’s where a company like Datadog (DDOG) comes in. Founded in 2010 during the cloud’s so-called “Wild West” phase – when businesses raced to migrate off-premise without tools to manage their sprawling IT infrastructure properly – Datadog initially became the go-to dashboard for engineers battling server crashes and latency spikes. The company is now considered the leader in application performance monitoring (APM) by offering a suite of tools that enable customers to keep an eye on how well their software applications are working. Its 2024 results, released just days ago, reveal a firm no longer content to merely monitor clouds but to orchestrate them by expanding into areas like cybersecurity and AI-driven insights with one unified platform.
Is Datadog taking on more than it can chew or is the company ready to take a bigger bite of the cloud pie?
Datadog is Still a Top Dog in Revenue Growth
Let’s start with some numbers from the 2024 earnings call. Datadog reported $738 million in Q4-2024 revenue (up 25% year-over-year) and nearly $2.7 billion for the full year (up 26%). While we love the continued strong double-digit growth, we also recognize that the upward revenue trajectory is slowly decelerating as the business matures. Expect more of the same in 2025: Datadog projects full-year revenue of about $3.2 billion, an increase of “just” 18% to 19%. Investors reacted to this horrific news as they usually do by sending shares of Datadog stock down about 8.5%.
Still, Datadog’s revenue growth remains fairly impressive, particularly given its scale and current market penetration. The company now serves 30,000 customers, up from 27,300 in 2023, with larger clients driving much of its growth. Customers generating more than $100,000 in annual recurring revenue (ARR) was up 13% from a year ago, while those contributing $1 million-plus ARR jumped 17%. These larger clients – including 45% of Fortune 500 companies – account for 88% of total ARR, highlighting Datadog’s deepening relationships with enterprises over mom-and-pop (i.e., small-and-medium-sized) businesses.
Another key way to measure the health of a SaaS-based business is the stickiness of the platform. The story is mixed here as well. More than 80% of customers use two or more products, half use four or more Datadog widgets, and 12% employ eight or more. However, the last time we checked in with the company, Datadog said its net retention rate, or its ability to upsell and cross-sell solutions, was “greater than 120%” without getting into much detail. Management reported that the trailing 12-month net revenue retention percentage was in “the high 110s” in Q4-2024 (a slight bump from the “mid-110s” the previous quarter). The gross retention rate appears stable at mid- to high 90s.
Datadog Learning New AI Tricks
Again, none of this is surprising. The same trends are emerging among other popular SaaS stocks, from CrowdStrike to Snowflake, as super-charged revenue growth just before and during the early years of the pandemic has given way to respectable and recurring double-digit performance. There is no reason to think that Datadog and these other SaaS companies won’t continue to grow at a reasonably rapid clip, given the size of the cloud services market.
The most successful ones will likely be those that can expand their platform portfolios as quickly and seamlessly as possible. For CrowdStrike, continued relevance includes building out an end-to-end cloud cybersecurity service. For Snowflake, future growth hinges on becoming an AI data cloud company. And Datadog’s strategy involves selling new cloud-adjacent products in areas like cybersecurity and AI analytics, which would appear to put it on a collision course with companies like Snowflake and CrowdStrike. For instance, more than 7,000 customers now use at least one Datadog cloud security product. Even though they approach cybersecurity differently, Datadog and CrowdStrike are certainly indirect competitors.
Despite its lofty ambitions, Datadog’s core strength remains its unified observability platform, which integrates infrastructure monitoring, log management, and APM. Together, these products represent about $2.75 billion in ARR:
- Infrastructure monitoring: $1.25 billion
- Log management: $750 million
- APM: $750 million
About $200 million (about 7% of total revenue) now comes from products outside of three core pillars, such as Large Language Model (LLM) Observability, a fancy way to say that the platform enables customers to monitor AI model performance. In fact, AI companies represented 6% of Q4-2024 ARR – double from a year ago – with about 3,500 customers using one or more Datadog AI integrations including tools for monitoring generative AI. As AI workloads become more complex, tools like LLM Observability prevent issues like model drift, hallucinations, and the annihilation of the human race. However, Datadog CEO and co-founder Olivier Pomel cautioned that GPU-driven cloud growth hasn’t directly benefited Datadog yet, especially since hyperscalers like AWS and Microsoft Azure bundle basic monitoring with cloud services.
Time to Add Shares of Datadog Stock?
Shares of Datadog may be down 20% year-to-date leading to “buy the dip” mantras, but tenured investors recognize that real “dips” are when there is blood in the streets. If you’re looking to add shares of a stock, use valuation benchmarks, not “dips” or arbitrary share price numbers. As long-time Nanalyze readers know, we developed a simple valuation ratio (SVR) to give us a quick-and-dirty way to evaluate if a high-growth tech stock we like is priced to buy. The ratio divides the market cap by annualized revenues. We compare the result with our Nanalyze Disruptive Tech Stock catalog average and factor in a premium associated with SaaS stocks like Datadog and Snowflake.
Currently, Datadog’s SVR is about 13 ($38.8 billion market cap/$2.95 billion in annualized revenue), a little more than twice the catalog average and close to our previous buy target of 12. That target was based on the below chart taken from just over two years ago when we first entered into our position.
Since then, the average valuation of Datadog has increased – the average is about 16 over the past rolling year (SVR averages can be found for many stocks in our Tech Stock catalog). That means the current SVR represents a meaningful enough discount to the average that adding shares makes sense, especially when you consider that they’re starting to generate some decent free cash flow now.
The Rule of 40
While we often focus heavily on revenue growth, not all revenues are created equal. Companies with strong gross margins stand out because that demonstrates the potential for future profitability (anything 80% or above is impressive and expected for a quality software company). Datadog’s gross margin in the low 80s means they can start reigning in costs to realize positive operating cash flows, and indeed they are.
The above table shows us various operating cost margins for categories such as R&D, “Sales and Marketing,” and “General and Administrative.” As these margins drop, the overall operating margin increases, which produces free cash flow. We can then add the annual revenue growth (row two) to the free cash flow margin (row eight) and that’s the old “Rule of 40.” Companies where this metric exceeds “40” show that they’re able to manage both growth and profitability, and Datadog is managing quite well in that respect.
Conclusion
Datadog’s forward-looking strategy revolves around expanding its role as the central nervous system for cloud operations, combining observability, security, and AI-driven insights into a unified platform. Record sales bookings of more than $1 billion in Q4-2024 suggest customers are very interested in the platform but flipping that number into real revenue will take time and money, and the challenge is to reduce costs while maintaining growth. At an SVR of 13 (about twice our catalog average), Datadog enjoys a premium valuation, but it seems deserved given their strong growth and cash flow generation as they work to control expenses. If we look to add shares to our position, Nanalyze Premium subscribers will be first to know.
Share
