One of the companies in the cloud computing space that has attracted considerable attention as a strong potential growth stock recently is Digital Ocean (NYSE:DOCN).
Here’s what you should know about whether Digital Ocean is a buy or a sell at the moment.
Digital Ocean Helps Small Firms Get On The Cloud
Digital Ocean is a cloud computing services provider that specializes in scalable cloud infrastructure. The company’s simple approach to cloud services allows developers to focus on software development, rather than building basic platform architecture. Unlike many of its competitors, Digital Ocean’s product offerings are curated specifically for SMBs instead of larger organizations.
At the core of Digital Ocean’s business are virtual machines known as Droplets. These machines can be optimized for a variety of uses, including memory and processing power. The company also offers a general-purpose Droplet that handles most general computing tasks well.
Droplets are scalable based on the needs of developers at each stage of a project. From initial development and testing to full rollout and product growth, developers can scale up their Droplet usage as required.
Digital Ocean also offers a simple, affordable pricing model that makes it more accessible for small businesses than many other cloud providers.
Under the company’s business model, customers are charged a monthly subscription fee based on their usage of the platform. This creates more transparency in pricing and allows Digital Ocean to offer its products at low prices. With packages starting at $5 per month, Digital Ocean has natural appeal to developers working on small budgets.
One of the more unique aspects of Digital Ocean is its focus on creating a community around its platform. The company maintains a large forum where developers can assist each other by sharing information. This plays into Digital Ocean’s concept of making cloud development simple by giving its users a large database of tips that can help them bring their projects to fruition.
Another part of the Digital Ocean community is its library of tutorials that developers can use to get started and create their applications. Currently, the company offers more than 3,000 tutorials in its technical library. These tutorials range from simple installation walkthroughs to entire programming language lessons. As a result, developers with little to no prior experience can leverage Digital Ocean’s resources to create the digital products they wish to offer.
Digital Ocean Growth and Revenue
Although the company has only been public for about a year, its earnings report for Q3 2021 offers several reasons for investor optimism.
The company increased its revenue by 37 percent year-on-year to reach $111.4 million. This was based on an average revenue per customer of $61.97, up by 28 percent from the previous year. Based on Q3 results, Digital Ocean projects total revenues for 2021 to reach $426 million to $428 million.
Profit margins were also quite positive. Digital Ocean reported GAAP gross profits and adjusted gross profits of 61 and 80 percent of revenue, respectively. Loss from operations was just $1.7 million for the quarter. This translated to a non-GAAP diluted income per share of $0.12.
Per the Q3 earnings report, Digital Ocean also recently acquired open-source cloud platform Nimbella. This acquisition supports the company’s goal of simplifying the development process. While the Nimbella acquisition is a fairly minor addition to the company’s portfolio, it could help to attract new developers with limited experience to the Digital Ocean platform.
Is Digital Ocean a Good Buy?
On the surface, Digital Ocean stock seems to have several positive points. First and foremost, rapid revenue growth strongly favors the company over the next three years. By some estimates, DOCN could continue to grow by 30 percent or more until 2025.
Sustaining such rapid growth over such a long period is a difficult feat, but the scalable cloud computing model Digital Ocean pursues makes this growth possible.
The platform’s simplicity and transparent pricing also give it an obvious market advantage among smaller businesses and organizations. The approach appears to be working, given the increasing average revenue per customer metric reported in the Q3 earnings call.
Assuming new developers continue to join the platform while existing ones ramp up spending, Digital Ocean could have a recipe for extremely strong future performance.
The company also has the advantage of having a relatively small share in a market that is growing rapidly, presenting it with ample opportunities for the future.
By 2024, the cloud computing services market could reach $115 billion. While Digital Ocean will still have to compete with larger providers like Amazon Web Services and Google Cloud, the market could be so large that there’s room for several winners.
Speaking of the company’s potential market, it’s worth noting that that market will continue to expand as long as new businesses are started each year. Approximately 14 million new companies are founded every year, giving businesses that provide these companies with digital tools an ongoing source of new customers.
Among cloud service providers, Digital Ocean is uniquely positioned to cater to new businesses. With its simple tools and affordable pricing, it’s likely that new businesses will incline toward Digital Ocean over other cloud providers.
Digital Ocean also approaches cloud services with a global strategy. At present, less than 40 percent of the company’s revenues come from markets in North America. This, combined with its favorable pricing model, could make Digital Ocean a dominant provider in emerging markets where developers must work with limited budgets. As a result, the company could capture more global market share in the next few years than more expensive alternatives.
Turning to analyst ratings, Digital Ocean currently has 8 Buy ratings, 2 Holds and no Sells. The average 12-month target price is $84.56. This would represent a gain of 47.8 percent against the current share price of $57.22. While analyst target prices are never definitive, these ratings strongly suggest that the company has the potential to outperform the broader market over the next year.
Together, these factors create a decent argument for buying Digital Ocean stock. The company’s global strategy and focus on SMBs, combined with strong growth prospects, position it as a possible tech winner in the coming years.
Volatility, Valuation and Moat: How DOCN Stacks Up
The single biggest risk factor for Digital Ocean stock appears to be its volatility. The stock was offered at an IPO price of $47 in March 2021. On the day of the IPO, it closed somewhat down at $42.50. This relatively narrow pricing range, however, would soon give way to wild swings in share price. The 52-week low for the stock is $35.35, while the 52-week high is $133.40.
Even though it has sold off by more than 60 percent from its highest point, the company is also still somewhat expensive. With a price to sales ratio of roughly 13:1, the company is a pricey proposition. While the company’s rapid growth rate could justify this valuation, there are practically no scenarios under which it’s an underpriced bargain.
It’s also worth remembering that Digital Ocean operates in an increasingly competitive industry. Cloud computing has been of the major tech winners of the last few years, driving a surge in competition for users. Digital Ocean does have the advantage of targeting the relatively underserved SMB market. However, it’s difficult to say whether this niche approach will allow it to become one of the eventual winners of the cloud computing race.
Relating to market competitiveness, Digital Ocean may also suffer from a moat problem. All cloud computing companies, Digital Ocean included, have a relatively thin moat due to the number of competitors out there.
The cost and inconvenience of switching from one provider to another tend to aid customer retention, but this only goes so far. The unique problem that Digital Ocean faces is that its most successful clients will likely end up becoming too large for its SMB-focused offerings and moving elsewhere for enterprise-scale cloud services.
It should be noted that Digital Ocean does have counterbalances to some of these risks. The strong community that the company has developed, for instance, could help it retain customers more effectively than other cloud providers. Likewise, while larger companies may remain dominant in some markets, Digital Ocean’s global strategy will likely make it a larger force outside of North America.
Should You Buy or Sell Digital Ocean?
Taking all of this into account, Digital Ocean emerges as a bit of a mixed bag. The company’s outstanding growth prospects, rising revenue per customer and ability to address an underserved market all make it very appealing. The fact that the stock has sold off by more than half from its highs earlier this year also gives investors the chance at getting in before future growth begins to drive prices higher again.
On the other side of the equation, Digital Ocean obviously has some challenges. Its high market cap relative to sales likely makes it too expensive for pure value investors. Competition from other companies and the lack of a moat around its business could also blunt the growth projections that make Digital Ocean so appealing in the first place.
With that said, the pros of Digital Ocean seem to outweigh the cons. The company has developed a unique approach to addressing a portion of the cloud computing market that is not fully served by the larger providers. Given that new businesses will continue to need cloud computing services, Digital Ocean should have no difficulty attracting customers.
Overall, Digital Ocean appears to be a good possibility for generating high levels of growth, albeit at a fairly high risk. This stock may not be the right fit for more conservative investors, especially given the volatility that it has shown in the 11 months since its IPO. For risk-tolerant investors, however, Digital Ocean presents a decent opportunity to capitalize on the growing cloud computing market. As more SMBs begin making the shift to the cloud, Digital Ocean seems to be in a good position to see rapid growth.
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