Goldman Sachs divides the artificial intelligence (AI) boom into several different phases. The first is entirely focused on a semiconductor company Nvidia. The second focuses on infrastructure companies like Microsoft And Amazon. And the third focuses on software companies.
In a recent interview, Ben Snider of Goldman Sachs told CNBC that hedge fund managers began moving into AI software stocks in the third quarter. “The funds have moved a little away from”Magnificent Seven“equities and toward software,” he said, “and this was really the first quarter where we saw that.”
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Phases come and go, so there is plenty of time to invest in chipmakers and infrastructure companies. However, now is also a good time to start building positions in AI software stocks. Data Dog(NASDAQ:DDOG) checks that box, and Wall Street is extremely bullish. Of the 45 analysts who follow the company, 91% rate the stock as a Buy.
Datadog specializes in observability software. Its platform includes approximately two dozen products that help businesses monitor, analyze and resolve performance issues in their applications and infrastructure. These products are built atop a artificial intelligence (AI) that facilitates incident resolution by automating alerts, insights and root cause analysis.
Datadog’s broad portfolio allows businesses to consolidate their spend through a single observability platform, which is simpler than integrating tools from multiple vendors. This convenience has helped make Datadog a leader in observability software. But Forrester Search also recognized its leadership in AI for IT operations. “Datadog leads the pack in data analysis and visualization,” the analysts wrote.
Observability software helps businesses prevent problems and avoid costly IT outages. The need for these tools increases as IT environments become more complex. This means that cloud migration and AI proliferation are assets for Datadog. So, earlier this year the company introduced LLM Observability, a suite of performance monitoring tools for infrastructure and large language models that power generative AI applications.
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Datadog reported strong third-quarter financial results, beating estimates and raising its full-year guidance. The company increased its number of customers by 9% to 29,200, and the average spend per existing customer increased by more than 10%. In turn, revenue rose 26% to $690 million, and non-GAAP (adjusted) earnings jumped 27% to $0.46 per diluted share.
During the earnings conference call, CEO Olivier Pomel said: “We are seeing the first signs of traction for our LLM Observability product. » Also worth noting is that CFO David Obstler said AI companies accounted for 6% of annualized subscription revenue, up from 4% in the previous quarter and less than 3% the year before. This trend supports the thesis that Datadog could be a big winner as the AI boom unfolds.
Importantly, Datadog reported that its net revenue retention has been in the 110% average range for five consecutive quarters, implying something between 111% and 119%. However, David Obstler provided additional context during the third quarter call, saying that revenue retention was trending upward. This means existing customers are spending more at a faster rate, which bodes well for Datadog and its shareholders.
Looking ahead, the consensus estimate among Wall Street analysts is that Datadog’s adjusted earnings will grow 50% annually through 2026. Even against the backdrop of this rapid growth, the current valuation of 150 times earnings fitted seems expensive.
Patient investors can buy a very small position at the current price, provided they know the stock could fall 20% or more if Datadog fails to meet expectations or the stock market as a whole undergoes a correction. However, if such a pullback occurs, investors should seize the opportunity and buy more shares.
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John Mackey, former CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Trevor Jennevine has positions at Amazon and Nvidia. The Motley Fool holds positions and recommends Amazon, Datadog, Goldman Sachs Group, Microsoft and Nvidia. The Motley Fool recommends the following options: long January 2026 $395 calls on Microsoft and short January 2026 $405 calls on Microsoft. The Motley Fool has a disclosure policy.
