Datadog, Inc. (DDOG), a monitoring  and security platform for cloud applications, is currently trading more than four times higher than its 52-week low of $28.88. However, the stock has gained just 19.7% so far this year to close yesterday’s trading session at $117.85. While the company’s impressive performance last year can be primarily attributed to  increased demand for its products and services for remote working, it financials are still weak.

Also, as working people worldwide slowly return to working from company premises with a gradual retreat of COVID-19 risks, we think ‘stay-at-home’ stocks such as DDOG could witness a decline in demand for their offerings in the near term.

Here is why we think it is better to avoid DDOG for now:

Fading Pandemic-Driven Benefits

It is true that for the most part the remote work trend is here to stay, and thus companies that facilitate remote working with their unique offerings should continue to  perform well. However, because  workers  are  expected to resume working from their company locations as vaccines substantially beat back the  risks of coronavirus contagion, as is anticipated, , the demand for DDOG’s products and services that facilitated ‘work-from-home’ could reduce. In other words, it will be difficult for DDOG to replicate its impressive  2020 gains as the economy  opens up.

Moreover, since the national focus is now on economic recovery, investors might rotate away from expensive tech stocks to undervalued companies in  industries that could rebound with an  economic recovery.

Unjustified Premium Valuation

In terms of its forward p/s, DDOG is currently trading at 60.87x, which is 1309% higher than the 4.32x industry average. So, the company is highly overvalued, which we think is  unjustified given  other companies in the software space that are trading at lower valuations while generating comparable revenue growth. In terms of forward price/cash flow also, DDOG’s 406.38x is significantly higher than the industry average of 22.41x.

Weak Financials

DDOG  is scheduled to release its fourth-quarter and fiscal year 2020 financial results on February 11 after the market closes. Analysts expect the company’s EPS for the quarter to decline 33.3% year-over-year. DDOG reported net a loss of $15.15 million for the third quarter of 2020 (ended September 30, 2020), which widened from a net loss of $4.16 million in the third quarter of 2019. The company also reported a GAAP operating loss of $9.3 million. DDOG also reported net loss per share of $0.05 for the quarter, which also widened from the net loss per share of $0.04 a year ago.

Consensus Price Target Indicates Downside

Wall Street analysts expect the stock to hit $105.35 in the near term, which indicates a potential downside of 9.5%.

POWR Ratings Show Indicate Gloomy outlook

DDOG has an overall rating of D, which equates to Sell in our POWR Ratings system. The POWR Ratings are calculated by considering 118 different factors with each factor weighted to an optimal degree.

Our proprietary rating system also evaluates each stock based on eight different categories. The stock has a grade of D for Value, which is consistent with the stock’s significantly higher-than-industry p/s ratio. Its poor earnings outlook has earned the  stock a  D grade for Growth as well.

Beyond what I have stated above, DDOG is  graded for Stability, Momentum, Sentiment and Quality. Get all DDOG’s ratings here.

The stock is ranked #47 of 60 stocks in the C-rated Software – Business industry.

While DDOG has a bleak outlook, there are three  top-rated stocks in the same industry. Click here to learn about them.

Bottom Line

We believe DDOG could be overdue for a price correction because  it is trading at a significantly higher valuation than some of its competitors in the software space. The company’s main business looks healthy, but its weak financials make it difficult to justify its high valuation.

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DDOG shares were trading at $113.80 per share on Wednesday morning, down $4.05 (-3.44%). Year-to-date, DDOG has gained 15.60%, versus a 3.90% rise in the benchmark S&P 500 index during the same period.

About the Author: Manisha Chatterjee

Since she was young, Manisha has had a strong interest in the stock market. She majored in Economics in college and has a passion for writing, which has led to her career as a research analyst. More...

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