The Nasdaq Composite fell into a bear market in late 2021, and it has yet to rebound. In fact, the tech-heavy stock index is still down 28% from its high. Yet, some of the wealthiest hedge fund managers on Wall Street have been buying growth stocks throughout the bear market.
Last year, Jim Simons of Renaissance Technologies more than tripled his positions in Datadog (DDOG) and Zscaler (ZS). Meanwhile, Ron Baron of Bamco doubled his stake in Datadog, and Steven Cohen of Point72 Asset Management doubled his stake in Zscaler.
Is it time to buy these growth stocks that billionaires are buying hand over fist?
Datadog provides observability and security software for developers, operations teams, and security teams. Its platform offers real-time visibility across the corporate technology stack, helping businesses keep their critical systems and services performing and secure. Datadog provides hundreds of pre-built integrations that hasten deployment, and its artificial intelligence engine accelerates workflows by automating anomaly detection and root cause analysis.
Datadog received high praise from industry analysts. Consultancy firm Gartner named the company a leader in application performance monitoring last June, Forrester Research positioned Datadog as a leader in artificial intelligence for IT operations in December, and G2 recognized its leadership in cloud infrastructure monitoring and server monitoring in reports published this past winter.
Datadog’s strong competitive position translated into a strong financial performance last year. Revenue increased 63% to $1.6 billion, and cash flow from operations climbed 46% to $418 million. Better yet, investors have good reason to believe that momentum will continue.
Datadog is an innovation machine. In 2018, it became the first company to combine metrics, traces, and logs (i.e., the three pillars of observability) on one platform, and its portfolio continued to expand in the years since. It branched into user experience monitoring in 2019, developer testing and incident management in 2020, database monitoring and cloud security in 2021, and application security and cloud cost management in 2022.
Datadog’s capacity for innovation should keep it on the leading edge of observability software, a market that management values at $62 billion by 2026. Currently, shares trade at 12.5 times sales, a discount to the three-year average of 38.7 times sales, a reasonable price to pay given the potential upside. But while this growth stock is indeed worth buying, investors should start with a small position, then add to it in the event of a share price pullback.
Businesses traditionally secured their networks by placing a firewall around the corporate perimeter. All traffic is routed through a centralized IT hub, where it’s inspected and security policies are enforced. But that approach makes little sense today because data and applications often live in the cloud. Moreover, forcing traffic through a single data center creates bottlenecks that result in performance problems, and it provides subpar security compared to more modern solutions.
Zscaler’s security service edge (SSE) platform handles inspection and zero-trust policy enforcement in the cloud, eliminating the cost and complexity of on-premises security appliances. Better yet, Zscaler operates the largest network security cloud in the world. Its platform captures 300 trillion security signals on a daily basis, each of which makes its artificial intelligence engine better at identifying malicious behavior. That advantage allows Zscaler to provide better threat protection than other vendors, according to management.
Indeed, Gartner recognized Zscaler as an industry leader for the last 11 years, and Forrester Research recently recognized the company as a leader in zero-trust network access, noting that Zscaler has more mindshare than any other vendor. Thanks to that advantage, the company delivers solid financial results like clockwork.
One of the most impressive metrics is the dollar-based net retention rate, which exceeded 125% for the past nine consecutive quarters. That means the average customer spends over 25% more each year. In turn, over the past year, revenue climbed 57% to $1.3 billion, and free cash flow rose 41% to $277 million.
Going forward, investors have good reason to believe Zscaler can maintain its growth trajectory. Gartner estimates that 80% of enterprises will adopt SSE solutions by 2025, up from 20% in 2021. More broadly, digital transformation contributed to an increase in cybercrime, so zero-trust security became a top priority for many organizations.
Zscaler is perfectly positioned to benefit from those trends. Yet the company has captured less than 2% of its $72 billion addressable market, leaving plenty of room for future growth.
Presently, shares trade at 11.8 times sales, a discount to the three-year average of 36.6 times sales. That does indeed create a buying opportunity for patient investors.
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Source: The Motley Fool