This is why long-term oriented investors are buying the dip on DigitalOcean
The company acts like a venture capitalist
Disclaimer: This article is not financial advice. All content should be considered opinionated. We are not responsible for any gains and losses. Please talk to a financial advisor before making any investment decisions.
In DigitalOcean's Q4 2021 earnings call, CEO Yancey Spruill said:
"At the same time, those customers spending less than $50 per month give us an incredible option on their future success. As so many of these customers will launch an idea that they test on DigitalOcean and ultimately turn it into a thriving and rapidly growing business."
When I first heard the CEO describe the opportunity as an "option", I thought of it as an alternative path of growth. But after reading this article, I gained the perspective that their small customers act as the financial version of "options" for the company.
It's important to note that while DigitalOcean has over 600,000 customers, only 16% of them spend more than $50 a month on their services. That means that 84% of DigitalOcean's customers can be seen as having "option-like" potential. With 16% of DigitalOcean's customers accounting for 83% of the company's sales, investors can draw similarities between the company and your average venture capital firm.
For context: Venture capitalists source most of their returns from only a tiny percentage of their investments. Most VC investments either perform average or underperform the S&P 500 or even go bust.
Because DigitalOcean is focused on providing cloud computing services to young companies, the company is able to hook young companies onto their services while they're young so that as they grow, the company grows alongside them. And unlike a venture capitalist, who might sell their stake in a startup on the IPO, DigitalOcean will continue providing cloud computing services for as long as the company is alive. The growth potential that comes with this strategy is why investors are highly bullish on DigitalOcean.
Additionally, by banking on the growth of smaller businesses, DigitalOcean is able to utilize the Law of Diminishing Returns to its favor. Since it's much easier for smaller firms to double in size compared to larger businesses, it would mean that it would be easier for DigitalOcean to see its revenues grow faster compared to its competitors.
Another reason to be bullish on DigitalOcean is the fact that they're providing cloud computing services at a lower price compared to Amazon and other Big Tech firms. This aspect is what makes DigitalOcean more attractive to startups than AWS. At the same time, since DigitalOcean is smaller and more focused on helping small businesses, they're able to provide personalized services that Amazon and other Big Tech platforms wouldn't take time out of their day to provide.
Regarding the DigitalOcean's biggest strength: pricing, those who've seen the show Silicon Valley or who've worked in a startup would understand how expensive cloud computing costs are. Dropbox saved more than $75 million just by building their own cloud infrastructure. With the dynamic nature of the startup world, cloud computing costs can creep up when least expected and drive startups to bankruptcy. Thankfully, startups can reduce that issue by choosing to rely on DigitalOcean for their cloud services.
Because nearly all of DigitalOcean's clients are small businesses, DigitalOcean holds immense growth potential. With that, DigitalOcean gets to ride the wave of growth of numerous small businesses. If ever some of those businesses do become very big, because they're already hooked onto the DigitalOcean platform, DigitalOcean will reap huge fortunes from their clients' success.
That characteristic of DigitalOcean is why many investors continue to hold onto their shares and buy the dips on the company's shares. DigitalOcean's future is bright as they help startups continue doing business without worrying about expensive cloud computing bills.
As the markets remain volatile, those looking to buy the dips on DigitalOcean should hold a long term perspective on it. Today, DigitalOcean holds immense growth potential and investors haven't forgotten. That's why their shares are currently trading at expensive multiples despite the stock market correction. The stock can continue to go lower as the current environment is creating a "multiples compression".
On the other hand, the stock market correction could end sooner than expected and tech stocks like DigitalOcean can continue roaring.
About the author
My views on markets, investment strategies, perspectives on events, etc. usually differ from the mainstream consensus.
*All views expressed in my articles are my own and should be considered opinionated