Datadog DDOG shares have plunged 10.5% in the trailing 12-month period, underperforming the Zacks Computer and Technology sector and the S&P 500 index’s return of 9.8% and 11.3%, respectively. The stock has also underperformed the Zacks Internet - Software industry’s appreciation of 19.3% in the same time frame.

Although the company’s market position is a strength, there are several factors that should caution investors. Let’s dig deeper to determine whether you should buy, sell or hold the stock.

Datadog’s One-Year Price Return Performance

Image Source: Zacks Investment Research

Market Competition and Pricing Pressure

Datadog faces increasing pricing pressure from competitors in the observability and cloud monitoring space. Its competitors include IBM IBM, Microsoft MSFT and Broadcom in the on-premise infrastructure monitoring space. In the Cloud monitoring market, Datadog competes with native solutions from cloud providers, such as Amazon’s AMZN Web Services, Google Cloud Platform and Microsoft Azure, besides facing stiff competition from Cisco Systems, Dynatrace and Splunk in APM and Log Management.

On top of the competitive pressures, customers are becoming more cost-conscious and seeking ways to optimize spending on cloud and observability tools. As a result, Datadog has experienced contract renewals with discounts, which impacted revenue growth. Other than that, some large enterprises are exploring in-house observability solutions to reduce costs, which poses a potential threat to Datadog’s long-term revenue growth.

Cost Escalations Might Hurt the Bottom Line

Datadog is suffering from cost escalations in the form of research and development (R&D), sales and marketing (S&M) and general and administrative (G&A) expenses that soared 29.4%, 31.3% and 29.6% year over year to $211.6 million, $173.3 million and $38.7 million, respectively, in the fourth quarter of 2024, a trend that will likely continue through the quarters in 2025. This is expected to hurt the company’s bottom line, at least in the near term.

DDOG Stock is Overvalued

Additionally, the company's valuation may be a concern for some investors, as the stock trades at a premium compared to the broader Zacks Internet - Software industry. As of the latest data, Datadog’s forward 12-month P/S ratio hovers around 11.35, reflecting investors' high growth expectations.

The Value Score of F suggests a stretched valuation for Datadog at this moment.

Price/Sales Ratio (F12M)

Image Source: Zacks Investment Research

DDOG shares are trading below the 50-day and the 200-day moving averages, indicating a bearish trend.

DDOG Shares Trade Below 50-Day & 200-Day SMAs

Image Source: Zacks Investment Research

Product Innovation Drives Market Position

Despite the challenges, Datadog continues to strengthen its market position through strategic product expansion and innovation. In the past year, the company introduced more than 400 new features and capabilities. Notable releases include LLM Observability, which enables businesses to monitor AI models, and BizAI for incident management and autonomous investigations. Additionally, Datadog launched Flex Logs, allowing cost-effective long-term data retention, and Datadog On Call, a modern scheduling solution for cloud service management.

Further reinforcing its security offerings, Datadog announced a partnership with Chainguard to improve container security and observability by integrating Chainguard's solutions into Datadog’s platform. This partnership will combine container observability with clear, prioritized actions to help engineering and security teams eliminate common vulnerabilities and exploits, and improve software development velocity.

AI and Cloud Growth Potential

Datadog is well-positioned to capitalize on the rapid adoption of AI and cloud technologies. In the fourth quarter of 2024, AI-native customers contributed 6% of ARR, doubling from just 3% last year. At the end of 2024, the company had 3,500 customers who used one or more Datadog AI integrations to send them data about their machine learning, AI, and LLM usage. 

Additionally, the company’s launch of LLM Observability and BizAI for incident management and autonomous investigations further enhances Datadog’s appeal to businesses adopting AI-driven solutions. As more companies integrate AI into their cloud environments, Datadog’s observability and security tools position it as a key player in this growing market.

Financial Performance and Market Outlook

Datadog's financial trajectory remains robust, with guidance for first-quarter 2025 projecting revenues between $737 million and $741 million, suggesting 20-21% year-over-year growth. The full-year 2025 outlook appears promising, with expected revenues between $3.175 billion and $3.195 billion and non-GAAP earnings per share in the range of $1.65-$1.70. 

The Zacks Consensus Estimate for 2025 revenues and earnings is pegged at $3.19 billion and $1.69 per share, respectively. This indicates a year-over-year improvement of 18.85% in the top line and a decrease of 7.14% in the bottom line. The earnings estimates have been revised downward by 2 cents over the past 30 days.

Image Source: Zacks Investment Research

Find the latest EPS estimates and surprises on Zacks Earnings Calendar.

Conclusion: Hold DDOG Stock for Now

Current valuations of DDOG stock suggest that investors might benefit from waiting for a better entry point. The company's solid product portfolio and market position are undeniable strengths, but challenges due to increased competition and cost escalations pose a threat to its near-term profitability. Investors should monitor for potential market pullbacks that might offer more attractive entry points, particularly given the broader tech sector's volatility.

The combination of robust product development, strategic market positioning and solid financial guidance makes Datadog a compelling long-term investment candidate. However, factors like cost-conscious spending by customers and the risk of enterprises shifting to in-house solutions could limit growth. Datadog currently has a Zacks Rank #3 (Hold). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Want the latest recommendations from Zacks Investment Research? Today, you can download 7 Best Stocks for the Next 30 Days. Click to get this free report

Amazon.com, Inc. (AMZN) : Free Stock Analysis Report

Microsoft Corporation (MSFT) : Free Stock Analysis Report

International Business Machines Corporation (IBM) : Free Stock Analysis Report

Datadog, Inc. (DDOG) : Free Stock Analysis Report

This article originally published on Zacks Investment Research (zacks.com).

Zacks Investment Research