Datadog Stock Offers Potential Amid Nasdaq Sell-Off and Growing AI Demand

The Nasdaq Composite (^IXIC 0.21%) experienced a remarkable surge in the first half of 2024, with a 20% gain and minimal volatility. However, the index’s fortunes took a turn in July, currently down 6.5% from its peak. Investors are grappling with weak economic data and a currency shock in Japan. Despite this setback, historical trends suggest that the U.S. stock market tends to reach new highs over the long term, presenting a potential buying opportunity for astute investors.

One stock that stands out amidst the Nasdaq sell-off is Datadog (DDOG -1.16%), which plays a unique role in the artificial intelligence (AI) revolution. Despite a 9.5% decline over the past month, the stock is now trading 39% below its all-time high, achieved during the tech frenzy in 2021. However, Wall Street analysts, as tracked by The Wall Street Journal, remain overwhelmingly bullish on Datadog, assigning it the highest-possible buy rating.

Datadog’s technology holds immense importance for modern businesses, with approximately 28,700 companies utilizing its expanding portfolio of software tools. The company is renowned for its cloud monitoring platform, which helps businesses detect and rectify technical bugs before they disrupt digital infrastructure. This capability is particularly crucial in the digital economy, where competition is just a click away. Datadog’s popularity extends beyond e-commerce, finding traction in consumer-centric industries such as financial services, entertainment, gaming, and healthcare.

In a bid to enhance its offerings, Datadog introduced Bits AI, an AI assistant embedded in its legacy products. Bits AI aids businesses in swiftly identifying the root cause of technical issues and even generates incident summaries, saving managers significant time on manual investigations. Furthermore, Datadog recently expanded its AI capabilities by launching an observability tool for large language models (LLMs), which are foundational to AI applications like chatbots and virtual assistants. This tool enables developers to monitor costs, diagnose LLM issues, and measure their quality by tracking responses from the chatbots they power.

Datadog’s AI revenue is experiencing rapid growth, with the company reporting $645.2 million in total revenue for the second quarter of 2024, a 27% increase from the previous year. CEO Olivier Pomel highlighted that 4% of the company’s revenue in June was specifically attributed to AI-native customers, doubling from 2% in the past year. Approximately 2,500 customers are now utilizing Datadog’s AI tools, representing around 8.7% of its total customer base.

Impressively, Datadog’s growth in both its legacy and AI businesses is occurring while the company effectively manages costs. Operating expenses rose by only 18.5% year over year during the second quarter, compared to 31.2% in the previous year. This prudent cost management has resulted in net income of $43.8 million, a significant positive swing from the $3.9 million net loss reported during the same period last year. Datadog’s ability to generate growth without burning significant cash showcases the strong organic demand for its monitoring and observability tools.

The bullish sentiment surrounding Datadog is reflected in the analysis of 43 Wall Street analysts tracked by The Wall Street Journal. Of these analysts, 29 have assigned the highest-possible buy rating to the stock, while seven others are in the overweight (bullish) camp. The remaining seven recommend holding the stock, with none suggesting selling. The consensus price target for Datadog is $144.89, representing a 27% increase from its current trading price. The highest target stands at $160, implying a potential 40% upside.

It is worth noting that Datadog’s stock was heavily overvalued during the tech frenzy in 2021, with a price-to-sales ratio (P/S) exceeding 60. However, the stock’s decline and solid revenue growth have brought the P/S ratio down to 17.8, which is 40% below its average of 29.9 since the company went public five years ago.