These growth stocks should benefit as spending on artificial intelligence software increases.
Ark Invest, an investment manager focused on disruptive technologies, believes artificial intelligence could boost software sales from $1.1 trillion today to $13 trillion by 2030. That forecast implies annual growth of nearly 50%, such that total spending could increase 1,080% by the end of the decade.
Investors hoping to capitalize on that colossal opportunity should consider Datadog (DDOG 0.17%) and ServiceNow (NOW -0.19%), two software stocks that come highly rated by Wall Street.
- Among the 43 analysts that follow Datadog, 86% rate the stock a buy and the remaining 14% rate the stock a hold.
- Among the 40 analysts that follow ServiceNow, 90% rate the stock a buy, 8% rate the stock a hold, and 3% recommend selling the stock.
Here’s what investors should know.
1. Datadog
Datadog sells observability software. Its platform spans nearly two dozen applications that help businesses monitor, analyze, and troubleshoot performance problems across their IT infrastructure. Those products feed information to Watchdog, an artificial intelligence (AI) engine that expedites incident resolution by detecting anomalies, surfacing insights, and automating root cause analysis.
In August, consultancy Gartner recognized Datadog as a leader among observability platform vendors for the fourth consecutive year, commenting that its software “resonates well with enterprises looking for best-of-breed solutions.” Datadog also has a strong presence in other software verticals, including cloud infrastructure monitoring, log monitoring, and server monitoring.
Datadog’s robust portfolio is a key advantage. It not only creates cross-sell opportunities, but also businesses usually prefer the simplicity of comprehensive platforms to the complexity of buying products from multiple vendors. One new product presents a big opportunity given the growing demand for AI software: LLM Observability is a performance monitoring solution for large language models and generative AI applications.
Datadog delivered second-quarter financial results that exceeded Wall Street estimates on the top and bottom lines. Revenue increased 27% to $645 million and non-GAAP earnings jumped 48% to $0.43 per diluted share. Those figures reflect a 10% increase in customers, and a mid-teens increase in spend per existing customer. Management also raised full-year guidance, such that revenue is forecast to increase 23% in 2024.
Looking ahead, earnings estimates from Wall Street analysts vary widely because Datadog is still a relatively young company that is investing aggressively in product development and marketing. For that reason, it makes more sense to value the stock using its price-to-sales ratio. And at 19.7 time sales — a discount to the three-year average of 23.8 times sales — the stock is not cheap, but the price is fair given that the company has tapped less than 5% of its $51 billion addressable market.
2. ServiceNow
ServiceNow provides software that digitizes business processes. While best known for its IT applications, its platform also includes products for (1) customer workflows like customer service management, (2) employee workflows like human resources delivery, (3) creator workflows like application development and process automation, and (4) finance and supply chain workflows like procurement.
ServiceNow has been building AI into its software for years. For instance, predictive intelligence makes recommendations about what action users should take to resolve issues, AI search helps users find answers to questions quickly, and virtual agents automate customer service interactions. More recently, ServiceNow debuted a suite of generative AI tools called Now Assist that summarize information and draft text.
ServiceNow is the market leader in IT service management, IT asset management, and AI for IT operations software. Analysts have also recognized its leadership in other verticals, such as multicloud and hybrid cloud management, digital process automation, and customer service solutions. “Recent investments in generative AI and partnerships with Nvidia will keep ServiceNow at the forefront of innovation for years to come,” wrote IDC analysts in June.
ServiceNow reported second-quarter financial results that beat Wall Street estimates on the top and bottom lines. Revenue increased 22% to $2.6 billion due in part to momentum with generative AI products, and non-GAAP net income increased 32% to $3.13 per diluted share. The company also recorded a renewal rate of 98%, and its remaining performance obligation jumped 31%, hinting at strong revenue growth in future quarters.
Wall Street expects ServiceNow’s adjusted earnings to increase at 20% annually through 2025. That makes its current valuation of 72 times adjusted earnings look at bit pricey. But I think ServiceNow will grow faster than anticipated given that management believes its addressable market will reach $275 billion by 2026, and Now Assist is “the fastest-growing new product in the company’s history,” according to CEO Bill McDermott.
Patient investors should feel comfortable buying a small position in this AI software stock at its current price. In the likely event that shares pull back at some point, investors should consider buying more stock on the dip.
Trevor Jennewine has positions in Nvidia. The Motley Fool has positions in and recommends Datadog, Nvidia, and ServiceNow. The Motley Fool recommends Gartner. The Motley Fool has a disclosure policy.
