How Do Value-Focused Investors See Datadog Shares?

One of the biggest losers as of today's afternoon session is software company Datadog, whose shares are down -6.9%, underperforming the Nasdaq by -6.0%.
At $94.84, DDOG is not far from its average analyst target price of $98.46.

The average analyst rating for the stock is buy. DDOG lagged -7.0% behind the S&P 500 index today, and by -9.0% over the last year, returning -5.1%.

Datadog, Inc. operates an observability and security platform for cloud applications in North America and internationally. The company is a technology company. Valuations in the technology sector are often very high, as investors are willing to overlook gaps in the fundamentals if they believe a company’s innovations can dominate or create new markets.

Datadog does not release its trailing 12 month P/E ratio since its earnings per share of $-0.27 are negative over the last year. But we can calculate it ourselves, which gives us a trailing P/E ratio for DDOG of -351.3. Based on the company's positive earnings guidance of $1.56, the stock has a forward P/E ratio of 60.8. As of the first quarter of 2023, the average Price to Earnings (P/E) ratio of US technology companies is 27.16, and the S&P 500 average is 15.97. The P/E ratio consists in the stock's share price divided by its earnings per share (EPS), representing how much investors are willing to spend for each dollar of the company's earnings. Earnings are the company's revenues minus the cost of goods sold, overhead, and taxes.

DDOG’s price to earnings ratio can be divided by its projected five-year growth rate, to give us the price to earnings, or PEG ratio. This allows us to put its earnings valuation in the context of its growth expectations which is useful because companies with low P/E ratios often have low growth, which means they actually do not present an attractive value.

When we perform the calculation for Datadog, we obtain a PEG ratio of 3.72, which indicates that the company is overvalued compared to its growth prospects. The weakness with PEG ratios is that they rely on expected growth estimates, which of course may not turn out as expected.

To better understand the strength of Datadog's business, we can analyse its operating margins, which are its revenues minues its operating costs. Consistently strong margins backed by a positive trend can signal that a company is on track to deliver returns for its shareholders. Here's the operating margin statistics for the last four years:

Date Reported Total Revenue ($ k) Operating Expenses ($ k) Operating Margins (%) YoY Growth (%)
2022-12-31 1,675,100 1,387,052 -3.5 -88.17
2021-12-31 1,028,784 813,695 -1.86 18.42
2020-12-31 603,466 487,042 -2.28 58.92
2019-12-31 362,780 293,971 -5.55 n/a
  • Average operating margins: -3.3%
  • Average operating margins growth rate: 10.9%
  • Coefficient of variability (lower numbers indicate less volatility): 50.2%

Another key to assessing a company's health is to look at its free cash flow, which is calculated on the basis of its total cash flow from operating activities minus its capital expenditures. Capital expenditures are the costs of maintaining fixed assets such as land, buildings, and equipment. From Datadog's last four annual reports, we are able to obtain the following rundown of its free cash flow:

Date Reported Cash Flow from Operations ($ k) Capital expenditures ($ k) Free Cashflow ($ k) YoY Growth (%)
2022-12-31 418,407 -64,889 353,518 41.11
2021-12-31 286,545 -36,025 250,520 201.08
2020-12-31 109,091 -25,883 83,208 10419.34
2019-12-31 24,234 -23,443 791 n/a
  • Average free cash flow: $172.01 Million
  • Average free cash flow growth rate: 359.8%
  • Coefficient of variability (the lower the better): 92.7%

Free cash flows represents the amount of money that is available for reinvesting in the business, or paying out to investors in the form of a dividend. With a positive cash flow as of the last fiscal year, DDOG is in a position to do either -- which can encourage more investors to place their capital in the company.

Value investors often analyze stocks through the lens of its Price to Book (P/B) Ratio (its share price divided by its book value). As of the first quarter of 2023, the mean P/B ratio of the technology sector is 6.23, compared to the S&P 500 average of 2.95. The book value refers to the present value of the company if the company were to sell off all of its assets and pay all of its debts today - a number whose value may differ significantly depending on the accounting method. Datadog's P/B ratio indicates that the market value of the company exceeds its book value by a factor of 20, so it's likely that equity investors are over-valuing the company's assets.

As of first quarter of 2023, Datadog is likely overvalued because it has a negative P/E ratio, an elevated P/B ratio, and a pattern of improving cash flows with an upwards trend. The stock has poor growth indicators because of its consistently negative margins with a positive growth rate, and a negative PEG ratio. We hope this analysis will inspire you to do your own research into DDOG's fundamental values -- especially their trends over time.

The above analysis is intended for educational purposes only and was performed on the basis of publicly available data. It is not to be construed as a recommendation to buy or sell any security. Any buy, sell, or other recommendations mentioned in the article are direct quotations of consensus recommendations from the analysts covering the stock, and do not represent the opinions of Market Inference or its writers. Past performance, accounting data, and inferences about market position and corporate valuation are not reliable indicators of future price movements. Market Inference does not provide financial advice. Investors should conduct their own review and analysis of any company of interest before making an investment decision.