Investing in the Future: A Spotlight on DigitalOcean’s AI Strategy

With the new year approaching, investors have an opportunity to explore promising stocks. Artificial intelligence (AI) remains a powerful trend on the market, likely maintaining its momentum into 2025. DigitalOcean (NYSE: DOCN) is poised to benefit from this trend as it carves out a niche in the AI landscape.

DigitalOcean’s Unique Positioning in a Competitive Market

The cloud computing field is dominated by heavyweights like Amazon Web Services, Microsoft Azure, and Alphabet‘s Google Cloud. These giants focus on larger businesses due to their significant budgets, often overlooking small and mid-sized companies (SMBs).

Seeing this gap, DigitalOcean specifically caters to SMBs, targeting companies from startups to those with 500 employees—a $114 billion segment within the cloud market. By offering transparent pricing, personalized support, and user-friendly tools, DigitalOcean addresses the needs of SMBs that may lack extensive technical resources.

In its latest move, DigitalOcean announced fractional GPU capacity, allowing SMBs to utilize one to eight GPUs, including those supplied by Nvidia. This innovation enables even the smallest businesses to harness AI for various applications, like customer service chatbots.

What sets DigitalOcean apart is that major players like Microsoft Azure and Amazon Web Services are unlikely to serve this smaller segment, leaving a vast market for DigitalOcean to pursue. Demand appears strong; in the third quarter of 2024 (ending September 30), DigitalOcean reported a nearly 200% increase in AI revenue compared to the same quarter last year.

Image source: Getty Images.

Transforming Startups into Success Stories

DigitalOcean aims to onboard clients at the startup level, knowing that even a handful of successful businesses can significantly boost its revenue. Currently, the company serves 638,000 customers, of which approximately 474,000 are “learners” spending $50 or less monthly, while 145,000 are “builders” averaging $138 in monthly spending.

The smallest yet most lucrative group consists of “scalers”: 18,000 customers averaging $2,153 per month. These scalers contributed 33% to DigitalOcean’s $198.5 million revenue during Q3 2024, highlighting their importance despite representing only 2.8% of the total customer base.

Although overall revenue grew by 12% year over year, revenue from scalers surged by 19%, indicating strong growth in DigitalOcean’s most profitable segment.

Understanding the Value of DigitalOcean’s Stock

DigitalOcean’s stock is currently down 68% from its peak during the tech boom in 2021 when it was highly overvalued, with a price-to-sales (P/S) ratio around 30. Now, following a decline and increased revenue, the P/S ratio has fallen to 5.1, which is among the lowest since the company went public three years ago. The stock would need to rise 67% just to reach its average P/S ratio of 8.5.

DOCN PS Ratio data by YCharts.

Additionally, DigitalOcean is now profitable. The company posted earnings per share (EPS) of $0.87 over the last four quarters, leading to a price-to-earnings (P/E) ratio of 46.2. Although this may seem high compared to the Nasdaq-100 which trades at 33.9, DigitalOcean’s EPS increased by an extraordinary 1,800% year over year during the first three quarters of 2024, suggesting the potential for a lower P/E ratio in the future as profitability grows.

As the stock market heads into 2025 near record highs, finding undervalued stocks can be challenging. Nevertheless, DigitalOcean stands out as a potential buying opportunity due to its current valuation compared to its historic average, especially with the growing interest in AI technologies among SMBs.

A Renewed Opportunity in Investment

Have you ever felt like you missed out on investing in major stocks? You may not want to let this chance slip by.

Occasionally, our team of analysts identifies “Double Down” stock recommendations for companies positioned for significant growth. If you’re concerned about having missed previous investment opportunities, now is the ideal time to consider DigitalOcean before it rebounds. The numbers are compelling:

• Nvidia: An investment of $1,000 when we doubled down in 2009 would have grown to $359,936!*
• Apple: A $1,000 investment in 2008 would now be worth $46,730!*
• Netflix: If you had invested $1,000 in 2004, it would have grown to $492,745!*

Currently, we are offering “Double Down” alerts for three exceptional companies, so consider this a timely opportunity.

See 3 “Double Down” stocks »

*Stock Advisor returns as of December 9, 2024

John Mackey, former CEO of Whole Foods Market, an Amazon subsidiary, serves on The Motley Fool’s board of directors. Suzanne Frey, an executive at Alphabet, also holds a position on this board. Anthony Di Pizio does not have any positions in the stocks mentioned. The Motley Fool recommends positions in and endorses Alphabet, Amazon, DigitalOcean, Microsoft, and Nvidia, and it has a disclosure policy.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.