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The cloud computing and artificial intelligence (AI) space is rapidly evolving. Many new entrants are attempting to make a mark, while battling the fierce competition already in the market. Few can match up to the success of cloud giants such as Amazon (AMZN), Microsoft (MSFT), and Alphabet (GOOGL), which together account for 66% of the cloud computing market.
However, relatively small player DigitalOcean Holdings (DOCN) has caught attention with its outstanding revenue and earnings growth, as well as strategic investments in AI and machine learning (ML). Last week, the company announced another strong quarter.
In 2023, DigitalOcean stock skyrocketed 44%, outperforming the S&P 500 Index ($SPX), which gained 25% last year. DOCN stock has risen 3% year to date. Let's see if this small-cap stock is a good investment now.
DigitalOcean Ends Fiscal 2023 Strong
Founded in 2011, DigitalOcean is a relatively new player in the cloud computing space. Its $3.4 billion valuation pales in comparison to the cloud giants, with their trillion-dollar market capitalizations. However, DigitalOcean's convenient and less expensive cloud platform has gained popularity among smaller businesses, start-ups, and individual developers. The company now serves over 640,000 customers across 190 countries.
In the recently reported fourth quarter, revenue came in at $181 million, reflecting an 11% year-over-year. Revenue also beat consensus estimates by $2.7 million. DigitalOcean’s annual run-rate revenue (ARR) also increased 11% to $730 million in the quarter. Adjusted earnings per share of $0.44 exceeded analysts' expectations by $0.07.
For the full year, the company's revenue rose by 20%, while earnings increased by an impressive 69%. Its net dollar retention (NDR), which measures changes in recurring revenue, fell to 96% in Q4, down from 112% in the prior-year quarter. However, average revenue per customer rose 6% from the year-ago quarter.
During the Q4 earnings call, CFO Matt Steinfort emphasized that 2023 was a challenging year, due to macroeconomic headwinds. Nonetheless, the company added 18,000 new customers. Management also highlighted that the company is working hard to bring NDR back above 100% this year.
Stronger Years Ahead
Last year, DigitalOcean acquired Paperspace to strengthen its position in the AI race. The company believes that integrating Paperspace's advanced technology into its platform will make it easier for customers to test, develop, and deploy AI and ML applications. This will also expand its target market.
Furthermore, the company now has a new CEO, Paddy Srinivasan, who took over the reins in January 2024. A new CEO with a fresh perspective could also steer the company toward greater growth and innovation.
Turning to guidance, management anticipates first-quarter revenue to be around $182 million to $183 million, which would represent a year-over-year growth of 10.5%, on average. Additionally, adjusted EPS could increase by 36% to land in the $0.37 to $0.39 range. Analysts' estimates fall within the same range.
For the full fiscal year 2024, adjusted earnings per share could grow between 1% to 5%, while revenue is projected to advance between 9% to 12%, respectively. The company also expects an adjusted free cash flow margin of around 19% to 21% of total revenue for the year.
By comparison, analysts expect EPS growth of 2.7% to $1.63 in fiscal 2024, accompanied by revenue growth of 10.7% to $767.3 million.
Looking further ahead to fiscal 2025, analysts predict revenue and earnings growth of 13.1% and 13.6%, respectively. Trading at 20x forward earnings and 3.9x forward sales, DigitalOcean seems reasonably valued for a growing AI stock.
What Does Wall Street Say About DigitalOcean Stock?
Following its Q4 earnings, Goldman Sachs analyst Gabriela Borges increased DOCN's target price to $42 from $33. The analysts believe that the company's strategic investments in AI and machine learning indicate potential growth in the coming quarters.
Overall, Wall Street has assigned a “moderate buy” to DOCN stock. Out of the 12 analysts covering DOCN, six have a “strong buy” recommendation, five suggest a “hold,” and one recommends a “moderate sell.”
DOCN stock has surpassed analysts' average price target of $37.10, although the Street-high estimate of $47 implies a potential 23% upside from current levels.
Can DigitalOcean Stock Win Big?
Amazon, Microsoft, and Google dominate the cloud market. Certainly, DigitalOcean might struggle to compete directly with these giants, who have a plethora of resources and sizable cash hoards to expand in the AI era.
Having said that, DigitalOcean is making significant progress in the cloud computing space with the help of AI to grow its revenue and earnings at a rapid pace. DOCN stock, at a reasonable valuation now, would be an excellent choice for investors looking to add exposure to cloud and AI stocks.
On the date of publication, Sushree Mohanty did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
