Investing in growth stocks is an ideal strategy for those with a high-risk appetite. Typically, quality growth stocks crush broader market returns in a bull run. Alternatively, valuations fall off a cliff when market sentiment turns bearish.
It’s imperative to identify companies that have the potential to grow their revenue and earnings over time, which should drive future cash flows and share prices higher. One such TSX stock is Shopify (TSX: SHOP), which has returned an emphatic 2,380% to shareholders since its initial public offering in 2015. However, a sluggish macro environment has driven Shopify stock lower by 64% from all-time highs.
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Is Shopify stock a buy, hold, or sell?
Despite the pullback, Shopify stock is valued at a market cap of $100 billion. Comparatively, the company is forecast to end 2023 with sales of $9.2 billion, an increase of 23% year over year. So, SHOP stock is priced at 11 times forward sales, which is quite steep.
Similar to several other tech stocks, Shopify continues to reinvest in growth, which results in tepid profit margins. For instance, in the second quarter (Q2) of 2023, its operating income stood at just $146 million, indicating a margin of 8.9%.
Shopify recently sold off its fulfillment business to improve the bottom line but reported an impairment charge of US$1.3 billion. Its steep valuation and unattractive profit margins make Shopify a high-risk investment at the current price. Here is a better growth stock you can buy today. Let’s see why.
The bull case for Datadog stock
Valued at a market cap of US$34 billion, Datadog (NASDAQ: DDOG) stock trades 46% below all-time highs. Datadog provides enterprise-facing tools that help monitor cloud-based operations across the tech stack. The demand for cloud-based applications is expected to expand in the upcoming decade, making DDOG stock a top investment today.
Priced at 17 times forward sales, Datadog stock trades at a higher multiple compared to Shopify. But Datadog also enjoys healthy profit margins, enabling it to report robust cash flows. It ended Q1 of 2023 with an operating margin of 18% and free cash flow of US$116.3 million.
Armed with US$2 billion in cash, this company is well positioned to reinvest in growth and pursue accretive acquisitions in the future.
More than 25,000 companies use the Datadog platform, 2,910 of which spend more than US$100,000 annually. Moreover, it has a diverse client base spanning multiple industries ranging from retail to healthcare.
Despite a cost-conscious demand environment, Datadog continues to expand its user base and drive higher adoption among existing ones. It reported annual recurring revenue of US$2 billion for the first time in Q1 due to higher customer engagement and adoption rates.
Around 43% of customers now use four or more products, up from 35% in the year-ago period. Further, 16% of customers use six or more products, up from 12% in 2022. Datadog also ended the March quarter with a dollar-based net retention rate of 130%, which suggests existing customers increased spending by 30% in the last 12 months.
The Foolish takeaway
Datadog is a better buy than Shopify due to its higher revenue-growth rates and stellar free cash flow margin of 24%. Shopify, however, is still struggling to report consistent profits, despite a much higher revenue base.
