The proliferation of artificial intelligence (AI) is having a positive impact on multiple industries, and cloud computing is one of the markets where the adoption of this technology is helping companies make a lot of money.
From hardware suppliers such as Nvidiawhose chips are used by cloud service providers (CSPs) to train AI models Oraclewhose infrastructure is rented by companies to train models and deploy AI applications, several technology companies have seen a nice increase in their revenues thanks to this technology. However, there is another area within the cloud computing niche where AI adoption is expected to grow at a healthy pace in the future.
According to market research firm Market.us, AI adoption in observability will increase 22.5% annually through 2033, generating nearly $11 billion in revenue by the end of the forecast period. Observability refers to the process of monitoring and analyzing a system’s output, performance, and logs. It is important because this process helps improve the reliability, security, and performance of applications.
The research provider further adds that 69% of observability solutions are cloud-based, thanks to their flexibility and scalability. Investors looking to tap into this emerging AI-related niche may want to consider taking a closer look Data hound (NASDAQ:DDOG). This company has made a name for itself in cloud observability and has started integrating AI into its offerings, a move that could help accelerate its growth.
Datadog could achieve healthy growth in the coming years
Datadog is already active in a market that will become quite large in the future. The company points out that the total observability market was estimated to be worth $51 billion by 2023, and could achieve an annual growth rate of 11% through 2027. The adoption of AI in this area should ideally drive the growth of this market in the long term.
The great thing is that Datadog already benefits from the observation options offered. The company’s third-quarter 2024 revenue rose 26% year over year to $690 million. Non-GAAP net income rose nearly 28% from the year-ago quarter to $0.46 per share. The company’s top and bottom lines exceeded Wall Street expectations of $0.40 per share in earnings on $665 million in revenue.
However, the stock fell following the release of third-quarter results on November 7. That’s because the company’s guidance of $711 million in revenue for the current quarter was in line with consensus estimates. But investors would do well to focus on the bigger picture as the company has raised its expectations for 2024. It now expects revenue of just under $2.66 billion this year, along with earnings of $1.76 per share.
Previously expected earnings of $1.64 per share, the updated revenue forecast also exceeds analyst expectations of $2.63 billion. Datadog’s updated forecast means revenue will rise 25% in 2024, while operating profit would rise 33% from last year. Better yet, analysts have also increased their earnings estimates for the coming years.
DDOG EPS estimates for next fiscal year data according to YCharts.
However, don’t be surprised if Datadog posts faster growth than analysts expect. We’ve already seen that the company is on the cusp of a huge end-market opportunity, and the great thing is that its AI-specific offerings are now gaining traction among customers.
Datadog CEO Olivier Pomel noted during the recent earnings conference call that about 3,000 of its customers used its AI-specific offerings at the end of the third quarter to monitor their use of machine learning, large language models (LLMs), and AI applications. Pomel added that the first group of customers to pay for the company’s AI sensing solutions “reduced the time spent investigating LLM latency, errors and quality from days or hours to just minutes.”
It’s worth noting that Datadog ended the third quarter with just over 29,200 customers, compared to 26,800 in the same quarter last year. The company launched its AI-specific observation solutions in August last year, indicating that its AI solutions have gained good traction and more than 10% of its customer base is already using them.
This also means that a large portion of its customer base has yet to adopt its AI solutions, suggesting that there is still plenty of opportunity for the company to cross-sell its new offerings. It turns out that Datadog customers have been spending more money on the platform and adopting more of its services.
For example, the number of customers using four or more Datadog products increased three percentage points last quarter to 49%. Those using more than six products increased by five percentage points to 26%. Once again, 12% of customers now use 8 or more products, compared to 8% last year.
This improved adoption of its products helped Datadog increase its remaining performance obligations (RPO) by 26% year over year to $1.82 billion last quarter. RPO is the total value of the company’s contracts yet to be fulfilled, so the sharp jump in this metric is an indicator that the company is on track to continue its robust growth going forward.
The size of the company’s addressable market and the growing adoption of its AI-specific offerings should help the company maintain strong levels of growth going forward.
Is the stock a buy now?
Datadog is growing at an impressive pace and also has a lot of room for growth in the future, as the discussion above indicates, but its valuation is on the expensive side. The stock currently has a price-to-sales ratio of almost 19, while earnings expectations are just under 60. Nasdaq-100 The index, on the other hand, has a forward earnings multiple of 31.
Datadog will therefore have to consistently achieve strong growth quarter after quarter to justify the expensive valuation. The good thing is that Datadog appears to be able to do this, thanks to the huge market it serves and the growing adoption of AI in the field of observability. This likely explains why Datadog has a price-to-earnings-growth ratio (PEG ratio) of 0.80, according to Yahoo! Finances.
A PEG ratio of less than 1 indicates that a stock is undervalued relative to the growth it is expected to deliver. So, investors who want to buy a growth stock and are willing to pay a premium valuation to do so may want to consider adding Datadog to their portfolios, as it could deliver healthy share price gains in the long term.
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Harsh Chauhan has no position in any of the stocks mentioned. The Motley Fool holds and recommends positions in Datadog, Nvidia, and Oracle. The Motley Fool has a disclosure policy.
