Nvidia Shares are up 255% in the past year, fueled by enthusiasm around artificial intelligence (AI). However, the company currently gets most of its revenue from AI hardware, a market that Ark Invest predicts will be 21 times smaller than AI software. This estimate seems plausible considering that companies rarely purchase chips and other data center hardware, but these products can power countless applications for years before needing to be replaced.
Elaborating on that, Sanjit Singh said Morgan Stanley sees Data hound (NASDAQ:DDOG) as one of the software companies best positioned to benefit from generative AI. Wolfe Research’s Alex Zukin expressed even more conviction in a note to clients last year. He said generative AI tailwinds could make Datadog the “fastest growing software company.” If that prediction comes true, Datadog might be the best AI software stock to buy.
Of course, investors shouldn’t put all their chips on a single company. The best strategy is to buy a basket of AI stocks, and Datadog deserves a place in such a basket.
Datadog is a leader in the field of observation software
Datadog sells observability software for development, operations and security teams. The platform includes 19 modules that provide real-time visibility into IT infrastructure, helping companies resolve performance and security issues impacting their systems, applications and services. The platform is powered by an artificial intelligence engine called Watchdog, which continuously analyzes billions of data points to surface proactive alerts, automate root cause analysis and accelerate incident recovery.
Datadog has received high praise from industry analysts. Most noticeably, Forrester research ranked the company as a leader in AI for IT operations, and Gartner recognized the company as a leader in application performance monitoring. In addition, peer reviews accessed through G2 consider Datadog to be a strong competitor in several other observability markets, including cloud infrastructure monitoring, server monitoring, and database monitoring.
In the future, the growing demand for AI software should provide support. Datadog has added integrations that support performance monitoring at every layer of the AI stack, from graphics processing units to machine learning models. It also launched LLM Observability, a performance monitoring solution built specifically for large language models.
The company also introduced a generative AI copilot called Bits AI, which will help companies investigate and respond to incidents faster.
Datadog reported encouraging fourth-quarter financial results
Datadog looked strong in the fourth quarter. Customer numbers rose 17% to 27,300, and the company reported a net retention rate in the mid-110s. This means that the average existing customer has spent at least 10% more.
In turn, revenue rose 26% to $590 million and non-GAAP net income rose 112% to $156 million. Management said the platform strategy – Datadog’s integration of nearly two dozen products – remained a key growth driver.
Also notable is that the remaining performance obligation (RPO) rose 74% to $1.8 billion. RPO measures the momentum of the sales pipeline, and the rapid expansion in the fourth quarter indicates that revenue growth could accelerate in the future. On that subject, JPMorgan Chase Analysts said Datadog grew RPO at the fastest pace in two years and called it the best bookings bend in their software coverage universe.
That’s just one data point, but it supports the idea that Datadog could be the fastest-growing software vendor as the AI boom unfolds. The company is certainly building momentum in that area. CEO Olivier Pomel said AI-native companies accounted for 3% of annual recurring revenue in the fourth quarter, up from 2.5% in the third quarter. Additionally, the use of AI integrations increased 75% in the fourth quarter.
Datadog has strong tailwinds and its shares are trading at an acceptable price
In summary, Datadog has a strong presence in several observability software markets, including AI for IT operations and application performance monitoring. The company is also responding to demand for AI with new products and integrations that accelerate incident investigations and support AI performance monitoring.
More broadly, Datadog has strong tailwinds behind its cloud migration and digital transformation activities. Any technology that makes enterprise IT environments more complex, including artificial intelligence, should drive demand for observability software. Datadog is well positioned to benefit, given its brand authority and broad portfolio.
The company was ranked No. 2 on the 2023 Fortune Future 50 list, an annual assessment of more than 1,700 companies based on their ability for long-term growth. Furthermore, Wall Street analysts expect Datadog to grow revenue 25% annually over the next five years. That consensus estimate makes the company’s current valuation of 20.6 times sales seem acceptable, though I wouldn’t call it cheap.
Could Datadog Become the Fastest Growing Software Company? Certainly, but it makes little difference whether that happens or not.
What actually matters is that Datadog should be a big beneficiary as companies invest in digital transformation and AI, which could deliver above-average returns for shareholders. Now is a good time for patient investors to buy a small position in this software stock, especially as part of an AI basket.
Should you invest $1,000 in Datadog now?
Consider the following before purchasing shares in Datadog:
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JPMorgan Chase is an advertising partner of The Ascent, a Motley Fool company. Trevor Jennevine has positions at Nvidia. The Motley Fool holds and recommends positions in Datadog, JPMorgan Chase, and Nvidia. The Motley Fool recommends Gartner. The Motley Fool has a disclosure policy.
The Best Artificial Intelligence (AI) Software Stock to Buy, According to a Wall Street Analyst — No, It’s Not Nvidia Originally published by The Motley Fool