Artificial Intelligence (AI) is Poised to Fuel Rapid Expansion in This Sector: One Stock Standing to Secure Major Gains from This Emerging Prospect

Artificial Intelligence (AI) is Poised to Fuel Rapid Expansion in This Sector: One Stock Standing to Secure Major Gains from This Emerging Prospect

The expansion of artificial intelligence (AI) is bringing about a favorable impact on numerous industries, and cloud computing is one of the sectors where the adoption of this technology is aiding companies in generating significant revenue.

Vendors such as Nvidia, whose processors are utilized by cloud service providers (CSPs) to train AI models, and Oracle, whose infrastructure is rented by companies to train models and deploy AI applications, are among the tech companies that have experienced a revenue surge because of this technology.

However, there is an additional field within the cloud computing industry where the adoption of AI is predicted to witness a steady growth rate in the near future.

As per market research provider Market.us, the integration of AI in the observability space is projected to increase at a compound annual growth rate of 22.5% through 2033, generating approximately $11 billion in revenue during the forecast period. Observability refers to the process of monitoring and analyzing a system's output, performance, and logs, which improves the reliability, security, and performance of applications.

Moreover, 69% of observability solutions are cloud-based, mainly due to their flexibility and scalability. Investors interested in tapping this emerging AI-related niche can explore Datadog (DDOG 0.05%), a company that has gained recognition in the cloud observability space and has started incorporating AI within its services, which could potentially boost its growth.

Datadog is expected to witness substantial growth in the coming years

Datadog is already operating in a market that is poised to become substantial in the future. The company highlights that the overall observability market was estimated to be worth $51 billion in 2023, and it is projected to achieve an annual growth rate of 11% through 2027. The integration of AI within this space should ideally boost this market's growth in the long term.

The good news is that Datadog is already capitalizing on the observability opportunity available. The company's revenue in the third quarter of 2024 grew 26% year over year to $690 million. Non-GAAP net income increased nearly 28% from the same quarter in the previous year to $0.46 per share. Both the top and bottom lines exceeded Wall Street's expectations of $0.40 per share in earnings on $665 million in revenue.

However, the stock declined following the release of its Q3 earnings on Nov. 7. This was because the company's revenue guidance of $711 million for the current quarter was in line with consensus estimates. However, investors should focus on the bigger picture, as the company has raised its 2024 guidance. It now anticipates nearly $2.66 billion in revenue this year, along with $1.76 per share in earnings.

The company's previous guidance of $1.64 per share in earnings, and the updated revenue guidance exceed expectations of $2.63 billion. This means that Datadog's revenue is projected to increase by 25% in 2024, and the bottom line will increase by 33% from the previous year. Analysts have also raised their earnings estimates for the next couple of years.

However, don't be surprised if Datadog manages faster growth than what analysts are predicting. We have already witnessed that the company is exploiting a large end-market opportunity, and the positive aspect is that its AI-specific offerings are starting to gain traction among customers.

Datadog CEO Olivier Pomel stated on the recent earnings conference call that around 3,000 of its customers were using its AI-specific offerings to monitor their machine learning, large language models (LLMs), and AI applications at the end of the third quarter. Pomel further added that the initial batch of customers utilizing Datadog's AI observability solutions has reduced the time spent investigating LLM latency, errors, and quality from days or hours to just minutes.

It's worth noting that Datadog ended Q3 with more than 29,200 customers, which was an increase from 26,800 in the same quarter in the previous year. Datadog launched its AI-specific observability solutions in August of the previous year, which indicates that its AI solutions have gained good traction with more than 10% of its customer base already using them.

This also implies that a substantial portion of its customer base is yet to adopt its AI solutions, indicating that there is still ample room for the company to cross-sell its new offerings. Interestingly, Datadog customers have been spending more money on its platform and are adopting more of its services.

For instance, the number of customers using four or more Datadog products increased by three percentage points year over year last quarter to 49%. Those using more than six products jumped by five percentage points to 26%. Again, 12% of its customers are now using eight or more products, compared to 8% in the previous year.

This enhanced adoption of its products helped Datadog increase its remaining performance obligations (RPO) by 26% on a year-over-year basis to $1.82 billion last quarter. RPO is the total value of the company's contracts that have yet to be fulfilled, which is an indicator that it is on track to maintain robust growth in the future.

The size of the company's addressable market and the growing adoption of its AI-specific offerings should help it maintain strong levels of growth in the future.

Is the stock a buy right now?

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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Datadog is thriving at an impressive rate and there's potential for even more expansion, as per the preceding conversation, yet its value is on the pricey side. The stock currently sets you back a nearly 19x price-to-sales ratio, with its forward earnings multiple barely dipping below 60. Meanwhile, the tech-packed Nasdaq-100 index flaunts a forward earnings multiple of 31.

In essence, Datadog needs to consistently produce robust growth quarter after quarter to back up its high valuation. The silver lining is that Datadog appears to be up to the task, thanks to the colossal market it's tapping into and the escalating acceptance of AI in the observability sector. This very likely contributes to Datadog boasting a PEG ratio of 0.80, as reported by Yahoo! Finance.

A PEG ratio beneath 1 hints that a stock might be undervalued considering the growth it's projected to achieve. Consequently, investors seeking a growth stock that's prepared to charge a premium valuation may want to think about introducing Datadog into their portfolios. Given its potential, Datadog could generate noteworthy stock price increases in the long term.

Investors looking to capitalize on the integration of AI in the observability space might consider exploring Datadog, a company that is already thriving in this niche. According to the text, Datadog has experienced significant growth, with its revenue in Q3 of 2024 increasing 26% year over year to $690 million. Furthermore, 69% of observability solutions are cloud-based, offering a substantial market opportunity for companies like Datadog.

The adoption of AI within Datadog's services is expected to boost its growth in the future, as demonstrated by the 3,000 customers using its AI-specific offerings by the end of Q3 2023. This indicates that there is still ample room for the company to cross-sell its new offerings to its existing customer base. As the observability market is projected to grow at an annual rate of 11% through 2027, potentially reaching $115 billion, Datadog's strong position in this market may lead to noteworthy stock price increases in the long term.

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