A new year is right around the corner, so this is a great time for investors to look at new opportunities. Artificial intelligence (AI) is arguably the most powerful theme in the stock market right now, and that's likely to continue in 2025. Therefore, it could be the best place for investors to find returns.
DigitalOcean (DOCN -2.81%) is playing a unique role in the AI revolution. It's one of the very few cloud computing companies building a portfolio of AI solutions targeted toward small and mid-sized businesses (SMBs), while most of its competitors are fighting over large enterprises that spend more money.
Shares of the cloud computing provider are sitting on a modest gain of 11% for 2024 so far, but the stock is still trading 68% below its all-time high from 2021. Here's why it could be the ultimate stock to buy on the dip in 2025.
Competing with giants in the cloud, and now AI
The cloud computing industry is dominated by Amazon Web Services, Microsoft Azure, and Alphabet's Google Cloud. They generate so much revenue that targeting small customers won't really move the needle, so they typically fight over larger organizations with a high spending potential.
DigitalOcean views that as an opportunity. It specifically targets SMBs, from those in the start-up phase to those with up to 500 employees, which it says is a $114 billion niche market within the cloud industry. DigitalOcean offers them cheap and transparent pricing, highly personalized service, and a simple dashboard that is easy to deploy. This is great for SMBs, because they usually don't have in-house technical teams.
Now, DigitalOcean is using that strategy to help SMBs participate in the AI revolution. Cloud giants offer their customers access to data center infrastructure with thousands of graphics processing units (GPUs) from suppliers like Nvidia, but SMBs don't need that much computing capacity.
That's why DigitalOcean recently announced fractional GPU capacity, which allows SMBs to use between one and eight GPUs (including those from Nvidia). That means they can deploy even the smallest of AI workloads, whether they be AI customer service chatbots or other software applications.
Here's the best part: Industry giants like Microsoft Azure and Amazon Web Services are unlikely to compete at that small scale, leaving a massive potential market for DigitalOcean to capture. There is significant demand already -- during the third quarter of 2024 (ended Sept. 30), the company said its AI revenue soared by nearly 200% compared to the year-ago period.
Image source: Getty Images.
DigitalOcean wants to convert start-ups into "scalers"
DigitalOcean likes to acquire customers in the start-up phase, even though they don't necessarily have abundant financial resources to spend on cloud and AI services. That's because if even a small portion of them find success, they can make significant contributions to the company's revenue.
Right now, the company has 638,000 customers in total. Around 474,000 of them are "learners," who have been on the platform for more than three months but have a monthly spend of $50 or less. Another 145,000 are classified as "builders," which are at a slightly more advanced stage and spend $138 per month, on average, with DigitalOcean.
The smallest cohort are the "scalers." DigitalOcean has just 18,000 of these customers, but they spend an average of $2,153 per month. During Q3 2024, they accounted for 33% of DigitalOcean's $198.5 million in revenue, despite accounting for just 2.8% of the customer base.
Although DigitalOcean grew its total revenue by just 12% year over year, revenue attributable to the scalers jumped by 19%. That's a great sign, because almost any company would want to see its highest-spending customer cohort growing the fastest.
DigitalOcean stock looks cheap right now
DigitalOcean stock is down 68% from its all-time high, which was set during the tech frenzy in 2021. It was unquestionably overvalued then, with its price-to-sales (P/S) ratio soaring to around 30.
The decline in its stock price, combined with the company's strong revenue growth since then, has pushed its P/S ratio down to just 5.1. That's near the cheapest level since the company went public three years ago, and the stock would have to soar 67% from here just to trade at its average P/S ratio of 8.5.
DOCN PS Ratio data by YCharts.
DigitalOcean is also profitable now, after abandoning its growth-at-all-costs strategy from a few years ago in order to improve its bottom line. The company delivered $0.87 in earnings per share (EPS) over the last four quarters, so its stock is trading at a price-to-earnings (P/E) ratio of 46.2. That isn't cheap at face value, because the Nasdaq-100 technology index trades at a P/E ratio of 33.9.
However, DigitalOcean grew its EPS by a staggering 1,800% (year over year) during the first three quarters of 2024, so its P/E ratio could shrink dramatically over the next few quarters as its profitability ramps up further.
The stock market is heading into 2025 near a record high, so finding good value isn't easy. However, DigitalOcean might be a great buy while it's still down significantly from its record high, especially considering the discount to its long-term average P/S ratio. Plus, this stock offers investors a unique way to play the AI boom as more small and mid-sized businesses start deploying the technology.
