Artificial intelligence (AI) has emerged as the next big thing in the business world. Tech giants such as Microsoft, Alphabet, Tesla, and Amazon have been investing heavily in AI technologies in an effort to strengthen their existing business lines or expand into new ones. With AI becoming increasingly embedded in our daily lives, this investment trend is likely to persist for the next several years.
Investing in alignment with secular trends is a wise strategy for success in the stock market. Hence, it only makes sense for retail investors to open stakes in prominent AI stocks such as Snowflake (SNOW 3.69%) and Datadog (DDOG 4.95%). But which of these two is apt to be the better investment pick over the long haul?
Snowflake
Cloud-native big data analytics and data warehousing company Snowflake helps break the silos of structured and unstructured data (stored on-premises or in the cloud), analyze it, and then derive rich contextual insights for clients. Its highly scalable and secure data platform can work seamlessly with all major cloud providers, such as Amazon Web Services, Google Cloud, and Azure.
Although it's not exactly an AI company, Snowflake's data platform is playing a pivotal role in enabling clients to implement their AI strategies. The company has built a repository of curated, optimized, and secure enterprise data -- which is a major building block for its clients' AI strategies. This can prove to be a key competitive edge for Snowflake.
Snowflake's Data Marketplace also enables clients to share data, which is a major requirement for AI workloads. In fact, in its fiscal 2024 second quarter (which ended July 31), 26% of Snowflake's clients were sharing data. Furthermore, as data sharing proves more and more profitable for clients, it is driving up the utility of Snowflake's platform. This, in turn, helps attract even more customers. Hence, Snowflake has also been benefiting from significant network effects.
Management expects the company to reach an annual run rate of $10 billion by its fiscal 2029 -- an ambitious target considering its trailing 12-month revenue of just $2.4 billion. However, considering the company's strong fundamentals, which include a large addressable target market (estimated to be $290 billion by calendar 2027), positive free cash flows, and robust balance sheet ($3.75 billion cash versus $297 million debt), its stock may grow rapidly in the coming years.
Datadog
Cloud-native observability and cybersecurity company Datadog's platform pools together diagnostic data from across the customers' entire technology stack (which includes servers, networks, applications, databases, software, and hardware) and analyzes it to provide clients with real-time, context-driven insights about application and IT infrastructure performance. This helps clients swiftly identify root causes of anomalies, threats, and vulnerabilities, and resolve them, which in turn mitigates the risk of major damage to the organization.
Datadog has also been focused on rapidly adopting generative AI technology. The company recently integrated a generative AI assistant called Bits AI with its platform to enhance the accuracy of troubleshooting for organizations with minimal human intervention. The company has also introduced a monitoring tool for large language models that helps detect challenges associated with them, such as model drift (degradation in performance) and model hallucinations (incorrect and nonexistent information or patterns). Forrester Research has recognized the company as a leader in artificial intelligence for IT Operations.
Datadog's robust second-quarter results, which included a 23% year-over-year jump in customer count and a 50% year-over-year jump in adjusted earnings per share to $0.36, bear testimony to the strength of the company's business, especially when customers have been optimizing their cloud spending. The company is now guiding for revenue of $521 million to $525 million for the third quarter, and $2.05 billion to $2.06 billion for fiscal 2023.
The choice between Snowflake and Datadog
On Amazon's third-quarter earnings call, CFO Brian Olsavsky highlighted the view that while 90% of global IT spending is still for on-premises infrastructure, that share will shrink to just about 10% in the next 10 years. The rapid adoption of cloud computing will drive the usage of cloud-native observability and security as well as cloud-native big data analytics platforms. Both Snowflake and Datadog are well-positioned to benefit from this secular trend.
However, investing in either of these companies is not without risks. Snowflake has also witnessed a significant year-over-year decline in its revenue growth rate, from 106% in fiscal 2022 to 70% in fiscal 2023, which ended on Jan. 31. The company expects year-over-year revenue growth to be 34% in fiscal 2024. Datadog's revenue growth rate also dropped dramatically from 78% in the first half of 2022 to 29% in the first half of 2023. The company is also not profitable on a GAAP (generally accepted accounting principles) basis.
Snowflake and Datadog also trade at price-to-sales multiples of 19.2 and 13.7, respectively, significantly higher than the software industry's median multiple of 2.1.
While investors' choice between Snowflake and Datadog depends on several factors such as growth prospects, risk tolerance, and investment objectives, the mission-critical nature of observability and cybersecurity services (as compared to analytics services) in the current uncertain economic environment makes Datadog a safer pick now. Coupled with its focus on profits, more reasonable valuation, and resilience to market fluctuations, it could prove to be a better pick in 2023.
