The cloud computing market has grown significantly in recent years. This growth can be attributed to the rise of emerging technologies such as artificial intelligence (AI), machine learning, and the Internet of Things (IoT), as well as the shift towards digital transformation, which has led to an increase in demand for data storage and processing capabilities.
Amazon (AMZN), Microsoft (MSFT), and Google (GOOGL) have dominated the cloud computing market. However, there are numerous emerging players attempting to make their mark in this space. One such company is DigitalOcean Holdings (DOCN), which has gained attention for its approach to serving startups and small businesses as a leading cloud infrastructure provider.
DOCN stock has gained 14.6% year-to-date, compared to the S&P 500 Index’s ($SPX) surge of 20%. Let’s find out if DOCN stock is a buy now.
DigitalOcean Sees Strong Growth in Q2
Sitting at a market cap of $3.8 billion, DigitalOcean doesn't appear to be much of a significant player in comparison to the trillion-dollar cloud giants.
However, DigitalOcean's user-friendly, cost-effective cloud solutions have gained popularity among small and medium-sized businesses (SMBs), start-ups, and individual developers. The company had approximately 638,000 customers as of Q2, an increase from 637,000 in Q1.
DigitalOcean has reported impressive revenue growth, thanks to a strong customer base and rising demand for cloud services. In Q2 of 2024, revenue rose 13% year-over-year to $192 million, exceeding consensus estimates by $3.8 million.
Annual run-rate revenue (ARR) also rose by 15% to $781 million. Management noted that, including the ARR from the Paperspace acquisition last year, the ARR for AI and machine-learning products increased by 200% year on year. Furthermore, the net dollar retention rate (NDR), which measures how much revenue a company retains from its existing customers, remained stable at 97%. Adjusted earnings per share (EPS) of $0.48 outperformed analysts' expectations by $0.09, reversing a loss in the previous year's quarter.
On the Q2 earnings call, CFO Matt Steinfort said that despite macroeconomic headwinds, the company expects NDR and expansion levels to remain stable until the end of the year. He went on to say, “To further improve our net dollar retention rate, we will continue our solid execution accelerating our product road map, refining our pricing and packaging models, and enhancing our customer success motions.”
AI Could Fuel Growth
On the balance sheet, DigitalOcean ended the quarter with $443 million in cash and cash equivalents. The company also generated $37 million in adjusted free cash flow during Q2.
DigitalOcean intends to “capitalize on the AI opportunity to fuel future growth.” Furthermore, a fresh perspective under new CEO Paddy Srinivasan, who began this year, may steer the company toward innovation and growth in the coming years.
For the third quarter, the company expects around 11.3% revenue growth and a 7.3% earnings increase, if the high end of the guidance is met.
Driven by the consistent performance of its core platform and strong demand for its AI platform, the company increased its full-year guidance. Revenue for the full fiscal year 2024 is expected between $770 million and $775 million, representing an 11% to 12% increase. The company also expects adjusted EBITDA margins between 37% and 39%, while adjusted earnings could range from $1.60 to $1.70, representing a 7% increase at the high end. Management also anticipates generating 15% to 17% of revenue as adjusted free cash flow.
By comparison, analysts expect a 5% increase in earnings to $1.67 per share, followed by an 11.7% increase in revenue to $773.9 million, for fiscal 2024.
Is DOCN Stock a Buy, Hold, or Sell on Wall Street?
Following another strong quarter, analysts at Oppenheimer, Goldman Sachs, JMP Securities, and a number of other firms all reiterated their "buy" equivalent ratings for the stock. According to Goldman Sachs analyst Gabriela Borges, the company's strategic AI investments will result in organic revenue growth of around "4-6 percentage point increase each year for the next three years."
More recently, Canaccord reiterated a “buy” rating and raised the stock's target price to $48 from $42. After speaking with management, the firm is confident in DigitalOcean's ability to "execute on its long-term opportunity as an SMB cloud provider."
Overall, on Wall Street, DOCN stock is a “moderate buy.” Out of the 13 analysts covering DOCN, six have a “strong buy” recommendation, six suggest a “hold,” and one recommends a “moderate sell.”
DOCN stock has surpassed analysts' average price target of $37.82. Its high price estimate of $47 implies a potential 11.4% upside from current levels.
Looking ahead to 2025, analysts predict revenue and earnings growth of 13.1% and 10.1%, respectively. Trading at 22 times forward 2025 earnings, DigitalOcean appears reasonably priced, for a growth stock with AI-related potential.
Can Digital Ocean Match Up to the Giants?
As Amazon, Microsoft, and Google dominate the global cloud computing arena with their 67% market share, Digital Ocean may find it hard to compete toe-to-toe with industry titans that hold a legacy portfolio, brand strength, and solid financial position.
However, by focusing on a specific segment of the market — SMBs, developers, and startups — it has established itself as a viable alternative to its larger competitors' more complex, expensive offerings. With strong revenue growth, expanding product offerings, and a focus on geographic expansion, DigitalOcean has significant upside potential. Long-term investors interested in small-cap growth stocks may find DOCN a valuable addition to their portfolios.
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.
