5 green flags for the future of Datadog

Datadog’s (NASDAQ:DDOG) the stock jumped 12% on Feb. 10 after the cloud-based software company released its fourth-quarter results.

Its revenue increased 84% year over year to $326.2 million, beating estimates of $34.8 million. Its adjusted net income jumped 268% to $70.2 million, or $0.20 per share, which also beat expectations by nine cents.

Those numbers were impressive, but a closer look at Datadog’s report reveals five bright green flags for the future of this high-growth company.

Image source: Getty Images.

1. A growing number of big customers

Datadog’s platform monitors the performance of different servers, databases, cloud services, and applications across an entire enterprise. It aggregates all of this real-time data into unified dashboards, making it easier for IT pros to spot and diagnose potential issues.

This decompartmentalising approach is gaining ground with large corporate clients. Datadog ended the quarter with 216 customers with annual recurring revenue (ARR) of at least $1 million, a 114% increase from a year ago. Its number of customers with an ARR of at least $100,000 increased by 63% to 2,010.

2. A high net retention rate

Datadog does not report its exact dollar net retention rate, which measures its revenue growth per customer year-over-year, quarterly.

But on the conference call, Chief Financial Officer David Obstler said the metric had topped 130% for the 18th consecutive quarter. Datadog maintains this high net retention rate with its “land and expand” strategy, in which it locks customers in with one or two products to sell additional products.

At the end of the fourth quarter, 78% of Datadog customers were using two or more of its products, up from 72% a year ago. Some 33% used four or more of its products, down from 22% in the prior year quarter, while 10% used six or more products, down from just 3% last year.

3. Acceleration of revenue growth (in 2021)

Datadog’s growing customer base, high retention rate, successful cross-selling strategies, and a few small acquisitions enabled it to deliver accelerated year-over-year revenue growth throughout the fiscal year 2021:

Period

Q4 2020

Q1 2021

Q2 2021

Q3 2021

Q4 2021

Revenue growth (YOY)

56%

51%

67%

75%

84%

Data source: Datadog. YOY = year after year.

For the first quarter of 2022, Datadog expects revenue to grow 68% to 70% year-over-year, easily beating analyst expectations for 54% growth.

For the full year, he expects his turnover to increase by 47 to 49%. This would represent a slowdown from its 70% growth in 2021, but it is still well above the consensus forecast of 36% growth.

4. Stable gross margins

Datadog’s adjusted gross margin also reached 80% in the fourth quarter, compared to 78% in prior quarters and the prior year.

He attributed this expansion primarily to more efficient cloud hosting costs. On the “medium to long term”, Obstler expects Datadog’s adjusted gross margin to remain in the “high 70s range”, indicating that it still has significant pricing power over its high-growth niche market.

5. Improve profitability under GAAP

Many high-growth software companies generate robust revenue growth with stable gross margins, but struggle to generate meaningful operating and net profits. Yet Datadog’s operating margins have steadily increased — both by generally accepted accounting principles (GAAP) and non-GAAP measures — over the past year:

Operating margin

Q4 2020

Q1 2021

Q2 2021

Q3 2021

Q4 2021

GAAP

(5%)

(6%)

(4%)

(2%)

3%

Non-GAAP

ten%

ten%

13%

16%

22%

Data source: Datadog.

Obstler attributed this continued expansion to “significant business efficiencies on strong revenue growth,” which offset its “aggressive investments” in “long-term opportunities, particularly in R&D and go-to-market.” . These investments include its acquisitions of Timber, Sqreen, Ozcode and CoScreen over the past year.

This operational efficiency helped Datadog post a slender GAAP profit of $7.2 million in the fourth quarter, a major improvement from its net loss of $16.2 million a year earlier.

For the first quarter, Datadog expects its non-GAAP earnings per share (EPS) to increase 67% to 100%. But for the full year, it expects its non-GAAP EPS to be roughly flat as it integrates its new acquisitions and ramps up its investments.

But are Datadog shares worth buying?

Datadog’s growth rates are impressive, but much of the growth is already priced into its stock at 36 times this year’s sales. However, there are still plenty of other high-growth software stocks trading at higher valuations.

Snowflake (NYSE: SNOW), which is also breaking down silos with its cloud-based data warehousing service, is trading at nearly 80 times this year’s sales. Analysts expect its revenue to more than double this year, but it remains deeply unprofitable by both GAAP and non-GAAP measures.

Cloudy (NYSE:NET), which provides content delivery and website security services, is trading at 57 times sales this year. Analysts expect its revenue to grow 52% this year, but it’s also not profitable by both GAAP and non-GAAP measures.

Datadog seems reasonably priced against these high-growth software peers, and it’s actually marginally profitable on a GAAP basis. Therefore, I think investors who can handle all the short-term volatility should accumulate shares of Datadog now. Its valuations make it a bit speculative, but all of its major growth indicators are pointing in the right direction.

This article represents the opinion of the author, who may disagree with the “official” recommendation position of a high-end advice service Motley Fool. We are heterogeneous! Challenging an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and wealthier.

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