Datadog's price surge today seems to be confirming the bullish analyst outlook on the stock. Ending the day at $144.45, DDOG has posted 6.6% gains, pushing the valuation of the stock even higher. Might the stock be overvalued, despite its buy rating?
The first step in determining whether a stock is overvalued is to check its price to book (P/B) ratio. This is perhaps the most basic measure of a company's valuation, which is its market value divided by its book value. Book value refers to the sum of all of the company's assets minus its liabilities -- you can also think of it as the company's equity value.
Traditionally, value investors would look for companies with a ratio of less than 1 (meaning that the market value was smaller than the company's book value), but such opportunities are very rare these days. So we tend to look for company's whose valuations are less than their sector and market average. The P/B ratio for Datadog is 18.6, compared to its sector average of 3.91 and the S&P 500's average P/B of 4.74.
Modernly, the most common metric for valuing a company is its Price to Earnings (P/E) ratio. It's simply today's stock price of 144.45 divided by either its trailing or forward earnings, which for Datadog are $0.56 and $2.03 respectively. Based on these values, the company's trailing P/E ratio is 257.9 and its forward P/E ratio is 71.2. By way of comparison, the average P/E ratio of the Technology sector is 30.01 and the average P/E ratio of the S&P 500 is 29.3.
If a company is overvalued in terms of its earnings, we also need to check if it has the ability to meet its financial obligations. One way to check this is via the so called Quick Ratio or Acid Test, which is the sum of its current assets, inventory, and prepaid expenses divided by its current liabilities. Datadog's Quick ratio is 2.07, which indicates that that its total liquid assets are sufficient to meets its current liabilities.
When we had up all the inflows and outflows of cash, including payments to creditors, we obtain Datadog's levered free cash flow of $632.37 Million. This represents the money left over from the company's operations that is available for reinvestment in the business, or for paying out to equity investors in the form of a dividend. Despite its positive cash flows, Datadog does not currently pay a dividend.
Shares of Datadog appear to be overvalued at today's prices — despite the positive outlook from analysts. But sometimes stocks with inflated valuations turn out to be strong performances for years, and even decades, such as Amazon. So be sure to do your own due diligence if you are interested in taking a long position in DDOG.
