In Red-Hot Cloud Computing Sector, these 2 Stocks are Top Dogs

Datadog (DDOG) and Dynatrace (DT) are two intriguing cloud computing stocks. Which is the better buy now? Let's break it down.

cloud formation

If you’re looking to invest for the long term, some people shy away from tech stocks, but cloud computing is one of the hottest segments of the market and not likely to go anywhere, anytime soon. In fact it’s only likely to grow as you move closer to retirement.

Why Cloud Computing Stocks Are Hot

As cloud infrastructure from Microsoft, Amazon and Google becomes the backbone of so many computing environments the margin for error on hosted applications has become razor thin.

If a core solution goes down for even a short spell that could mean disaster—or at the very least, very angry customers.

The rise of cloud computing has led to a surge in demand for cloud infrastructure monitoring to make sure all is working as it should.

Which Stocks Are Worth the Investment?

Investing in Microsoft, Amazon or Google for cloud computing would be incredibly expensive, so if you’re just getting into these stocks, I recommend looking at two of the emerging players in this space: Datadog (DDOG) and Dynatrace (DT)

A Look at Datadog (DDOG)
Datadog, with a market cap of $23 billion, is one of the leaders in the cloud infrastructure monitoring market. It’s particularly strong in public cloud monitoring and is rapidly expanding into the private cloud and on-premise environments as well.

The company’s supernormal growth rate – revenue was up 83% in 2019 – reflects that Datadog is signing customers left and right. Why?

Datadog has what’s arguably the best platform across the three core markets in monitoring. These include infrastructure monitoring (where it is the leader), application program monitoring (APM), and logging.

It hasn’t been as strong in the latter two markets, where Dynatrace, which I’ll discuss in a minute, and Splunk (SPLK) are the respective leaders. That said, Datadog is likely the best positioned to grab customers who want one vendor to cover their needs across all three monitoring markets.

The company went public at 27 last September, got off to a strong start and worked its way to 50 just prior to the pandemic. A sharp pullback of 40% set the stage for a fierce rally that didn’t abate until DDOG hit 99 in early July.

A good portion of that rally was fueled by both current and anticipated demand for monitoring solutions due to the work-from-home (WFH) movement and other factors driving users to cloud-based environments.

Datadog’s stock approached its last earnings report on August 6 having just spent several weeks consolidating in the 80 to 100 range (up roughly 100% from its pre-pandemic high). Suffice to say expectations were elevated.

Management reported a better-than-expected quarter, but maybe not good enough to send the stock to the next level. Shares fell sharply after the report and are now roughly 20% below their recent all-time high.

How was the quarter?
Revenue was up 68% to $140 million, beating by $4.6 million. Adjusted EPS of $0.05 beat by $0.04. Large customers (those spending over $100,000) grew by 419 to 1,015 over the last 12 months, and 68% of customers are now using more than two products, up from 40% in the year-ago quarter.

Looking forward, management’s full-year guidance came in better than expected too. Revenue is now seen up 57% to $570 million (versus $560 million prior consensus) while adjusted EPS should be between $0.11 and $0.13 (versus $0.05 consensus).

The big-picture takeaway is that customers are still spending to monitor their cloud applications but are being a little more cautious than investors would like. That translates to a correction in a rapid growth stock in which expectations were sky high.

Here’s what the chart looks like.

DDOG-081120

A Look at Dynatrace (DT)
Dynatrace, which has a market cap of $10.3 billion, plays in the same general market as Datadog but comes at it from a different angle. The company is best known for strength in application performance monitoring (APM), an area where a new state-of-the-art platform better meets customer needs across on-premise, private cloud, and public cloud solutions.

Like Datadog, Dynatrace is also branching out into other areas of monitoring, including infrastructure monitoring (Datadog’s strength) and log management (Splunk’s strength).

The company’s historical financial statements are somewhat messy because it was spun out by Thoma Bravo in 2014. Management retooled the business from 2013 to 2016 to take advantage of newer technologies and transition to a subscription business model, which coincided with the release of the aforementioned platform.

This transition is why fiscal 2019 revenue (ended March 31) was only up 8%, but revenue growth in fiscal 2020 was a much more impressive 27%. Adjusted EPS was $0.30.

Dynatrace reported quarterly results for the first quarter of its fiscal 2021 back on July 29 when it beat on both the top and bottom lines.

Revenue was up 27% to $156 million while adjusted EPS of $0.13 beat by $0.03. Management said many customers are beginning to monitor aspects of their IT environment beyond just applications, that customer retention is strong, and that it is winning many bids and selling more solutions to current customers. The number of customers with more than three solutions rose by 44% over the last six months.

One potential weakness is that Dynatrace isn’t adding as many new customers as analysts had hoped. New customer adds in the quarter were roughly half of what many analysts had expected. However, management notes that with the transition to the subscription model largely behind it Dynatrace can now begin to focus on new customer growth. We’ll see.

Like DDOG, DT was doing well before the pandemic then went through a sharp correction before surging to new all-time highs. DT peaked at 45 in July, just 22% above its pre-pandemic high. This translated to a muted reaction after the earnings report and a stock that remained in its consolidation phase, which was (mostly) in the 40 to 45 range.

That said, along with other growth stocks DT has pulled back recently. Shares are now 18% off their recent all-time high.

Looking forward, Dynatrace is expected to grow revenue to around $650 million this fiscal year (up 20%) and by 25% in fiscal 2022. Adjusted EPS should be up around 60% to $0.48 this year, and up 20% to $0.57 next.

Here’s what the chart looks like.

DT-081120

Which Cloud Computing Stock is the Better Buy?
Like many stocks that get lumped into the same group, Datadog and Dynatrace are similar, but different. In their specialized monitoring market they’re each stronger in different areas. Datadog has a market cap that’s roughly twice that of Dynatrace and is growing much faster. But its revenue base is slightly smaller and is not as profitable.

Expectations for both stocks were (and remain) very high and both are trading roughly 20% off their highs.

Both stocks represent ways to play future demand for automating and monitoring cloud-based computing environments.

For investors that want exposure to this market I wouldn’t advocate buying one over the other at this stage. Just like there’s no reason to argue for owning Microsoft (MSFT) over Amazon (AMZN), or Visa (V) over Mastercard (MC), or so many other great companies that play in the same sandbox, both Datadog and Dynatrace are attractive to me.

It’s not out of the realm of possibilities to see a tie-up of these two companies in the future, or see one (or both) be acquired by other large tech firms looking to boost their infrastructure monitoring offerings.

Long-term growth investors could do a lot worse than starting to accumulate a position in both DDOG and DT around these levels, and on deeper pullbacks.

For investors currently in these cloud computing stocks, I think both are good to hold on to given the future growth potential.

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