Forget Splunk — Datadog Is a Better Growth Stock

Source:-fool.com

How should investors play a volatile market? Do you invest in large-cap stocks that have huge cash reserves and strong cash flows? These companies also have the experience of surviving multiple recessions. With equity markets trading 20% below record highs, do you invest in dividend stocks that have seen their yields shoot up with a decline in stock prices?

I believe that you need to invest in growth stocks as they tend to outperform broader markets in the long term. It is impossible to time the market, and while growth stocks tend to be volatile, they also have created massive wealth for investors over the years.

For example, if you invested $1,000 in Splunk’s (NASDAQ:SPLK) IPO back in April 2012, the 58 shares purchased would be worth close to $8,000 right now. Splunk has been one of the most innovative players in the big data and analytics segment. Its enterprise-facing platform helps clients simplify critical functions and monitor a variety of applications. This enables customers to gain valuable insights and measure performance as well as response time, enhancing several aspects of their application lifecycle.

However, there is another company in the data monitoring space — Datadog (NASDAQ:DDOG) — that is growing at a faster pace. Datadog went public on Sept. 20 last year at $27 per share and has since gained close to 50% since then.

Six cartoons representing data analysis
IMAGE SOURCE: GETTY IMAGES.

What does Datadog do?

Datadog provides a monitoring and analytics platform for enterprises. Its software-as-a-service SaaS) product integrates and automates infrastructure monitoring, application performance monitoring, as well as log management services for clients. Datadog and Splunk are leveraging enterprise ability to better understand user behavior and track key business metrics.

Software applications are key to transforming organizations in terms of increasing customer engagement and improving operational efficiencies. Over the years, Datadog has created several products and aims to unify these tools into its integrated monitoring and analytics platform.

In 2012, Datadog launched its first infrastructure monitoring platform to handle cloud-native architectures. In 2017, it launched an Application Performance Monitoring (APM) product, while in 2018 it launched a log management product. Last year, Datadog added user experience monitoring, security monitoring, and network performance monitoring to its product portfolio.

Datadog has now become an end-to-end monitoring and analytics platform and is designed to be cloud-agnostic, making it easy to deploy.

Datadog’s platform primarily aims to address the IT operations management market. Market research firm Gartner estimated the addressable business opportunity in IT operations management at $37 billion. Given Datadog’s annual sales of $363 million in 2019, it still accounts for less than 1% of this market and has significant room to grow revenue in the upcoming decade.

What’s going right for Datadog?

In the fourth quarter of 2019, Datadog grew sales by 85% year over year driven by the company’s focus on supporting modern technology architecture. Datadog’s total customer base in 2019 stood at 10,500, up from 7,700 in 2018 and 5,400 in 2019.

In 2019, the number of customers with an annual run rate (ARR) of over $100,000 stood at 858, a growth of 89%. The average ARR of enterprise customers rose from $160,000 in 2018 to $230,000 in 2019. Comparatively, the average ARR of mid-market customers rose from $110,000 to $170,000 in this period.

Over 60% of customers are currently using two or more products, which increased Datadog’s net retention rate to 130%, indicating increased usage and adoption of newer products.

Datadog ended 2019 with operating cash flow of $24.2 million, up from $10.8 million in 2018 and $13.8 million in 2017. Its cash balance stood at $778 million, giving it sufficient room to support working capital and capital expenditure in the next 12 months.

What does Datadog expect in 2020?

Datadog forecast sales of $117 million to $119 million in the March quarter, indicating year-over-year growth of 68.5% at the midpoint. It estimates sales to grow 49%, or $535 million to $545 million in 2020.

However, these estimates may be revised downward due to the ongoing COVID-19 pandemic, which will drive enterprise spending lower. Equity markets will remain volatile, and investors will gain further insights into the state of the global economy once companies report their earnings.

Datadog is trading at a market-cap-to-forward-sales ratio of 22.6, which is far higher than Splunk’s ratio of 8.4. However, Datadog is also growing at a far higher pace and commands a premium valuation.

I am not bearish on Splunk. I just think Datadog is a better growth stock. Datadog provides an enviable set of products and services to enterprise customers, making it one of the top stocks to own in the SaaS segment.

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