Key Points

Datadog stock has rallied impressively in the past month or so, and it looks like it will continue higher thanks to growing AI use in the cloud. The company is investing aggressively in staffing and research to capitalize on the multibillion-dollar end-market opportunity it is sitting on. Earnings growth is set to improve, and that could lead to more upside in the market. 10 stocks we like better than Datadog ›

Datadog(NASDAQ: DDOG), a cloud observability and security solutions provider, had a torrid run on the stock market in the first three months of the year. It then hit a 52-week low on April 7, but the stock has made a remarkable comeback since then.

Shares have shot up 28% from their 52-week low, and the latest quarterly results show that it could continue soaring thanks to the demand for its cloud monitoring and security solutions being fueled by artificial intelligence (AI).

Let's see why this cloud computing stock seems capable of sustaining its rally.Image source: Getty Images

Datadog's business is getting an AI-powered boost

Datadog released its first-quarter 2025 results on May 6, reporting a 25% year-over-year increase in revenue along with a 5% increase in its bottom line.

Revenue and earnings were better than what Wall Street was expecting, but more importantly, the company's improved full-year guidance boosted investor confidence in the stock.

It is now expecting full-year revenue to grow by 20% to around $3.23 billion, higher than the consensus expectation of $3.2 billion. Management attributes the improved guidance to the growing interest in its AI-focused cloud observability and security tools.

CEO Olivier Pomel said on the latest earnings conference call: "We continue to see rising customer for next-gen AI observability and analysis. At the end of Q1, more than 4,000 customers used one or more Datadog AI integrations, and this number has doubled year over year."

Pomel added that the number of companies using his business' observability tool to manage large language models has doubled in the past six months. Datadog also says that AI-native customers boosted the company's year-over-year growth by 6 percentage points last quarter, which was three times the growth seen in the year-ago period.

Looking to shore up its AI capabilities further, management has acquired Eppo, a company specializing in helping companies compare multiple AI models simultaneously before building and deploying AI applications that could generate substantial value.

This move could improve the adoption of Datadog's AI products. And that could help the company capture a bigger share of the massive cloud observability and security market, while also encouraging existing customers to spend more money. The customer base increased by almost 9% last quarter to 30,500, which means that a large portion of it has yet to adopt its AI tools.

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The number of customers with annual recurring revenue (ARR) of more than $100,000 increased at a faster pace: almost 13% year over year in the first quarter. This suggests that the company is now winning bigger contracts as its customers use more of its products.

For instance, 13% of customers used eight or more of its products in the first quarter, up by 3 percentage points from last year. Those using six or more products increased by 5 percentage points year over year.

This increased adoption is likely to continue improving in the long run thanks to AI, allowing the company to capture a bigger share of the cloud security and observability market, which is currently worth $79 billion and is set to grow by double digits over the next three years.

Stronger earnings growth should be a tailwind for this stock

Datadog is forecasting its 2025 earnings to land at $1.69 per share at the midpoint of its guidance range, lower than its 2024 adjusted net income of $1.82 per share. The drop in earnings this year can be attributed to the company's higher hosting costs due to the growth in demand from some of its largest customers.

Datadog has been shoring up its sales force and research and development (R&D) team. The head count for the former increased by 25% year over year in the first quarter, while the latter's head count was up by 30%. As a result, its adjusted operating margin fell by 5 percentage points year over year in the first quarter to 22%.

However, the company expects its operating margin to exceed 25% in the long run, which should ideally lead to an improvement in the bottom line. This explains why analysts are expecting its earnings growth to pick up.DDOG EPS Estimates for Next Fiscal Year; data by YCharts. EPS = earnings per share.

Moreover, the stock's one-year median price target of $135, according to 46 analysts covering the company, would be a 19% jump from current levels. But this cloud stock could do better than that since the growing adoption of its services is thanks to a new catalyst in the form of AI. And that's why investors should consider buying Datadog before it soars higher.

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Harsh Chauhan has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Datadog. The Motley Fool has a disclosure policy.

1 Artificial Intelligence (AI) Stock to Buy Hand Over Fist Before It Soars Higher was originally published by The Motley Fool

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