An appealing balance between growth and profitability, now at a relative bargain
Jamie Louko (Datadog): Technology and software companies have fallen out of favor with most investors lately, but that doesn’t mean there aren’t high-quality businesses in the space. While most investors have fled from the tech sector, companies like Datadog have continued to post stellar adoption rates and profits.
Datadog operates application observability and performance monitoring software, which helps customers ensure that their digital applications and tech infrastructure are running smoothly and effectively. This is a need to have service for customers, so it makes sense that demand has remained relatively stable this year, despite the concerning economic backdrop. Datadog is a leader in the space, according to Gartner (IT -0.20%), which helped the company see 74% year-over-year top-line growth in Q2, reaching $406 million in revenue.
Importantly, Datadog sees profits and cash flows begin to flow in, signaling that it isn’t sacrificing profits to achieve artificially higher growth rates. Over the trailing 12 months, Datadog generated almost $354 million in free cash flow -- representing a 26% margin -- while keeping net income at $6.5 million.
This cash flow can help the company do something critical to thriving in this space: Innovate. Competition is fierce in the application performance monitoring space, with immense pressure from established rivals like Dynatrace (DT 0.46%). For Datadog to maintain its leadership status, the company must continue to build and release new products for customers, and Datadog has done that. As of August, the company announced the rollout of six products year to date, and it expects to roll out even more by the year’s end.
With shares down 58% from all-time highs, the company’s valuation has fallen from an egregious multiple to a much more acceptable (although still expensive) one. Shares trade at 74 times free cash flow, and while that’s expensive on an absolute basis, it is far lower than earlier this year, when was valued as high as 200 times free cash flow. Considering the company’s leadership and flawless execution in an industry expected to be worth $53 billion in 2025, Datadog looks worth paying up for.
