Datadog Inc (NASDAQ: DDOG) rallied as much as 10% on Thursday following news that it will replace Juniper Networks on the S&P 500 index on July 9.
For potential investors and those with a position in DDOG shares already, the leap into the S&P 500 isn’t just symbolic; it could prove a seismic shift in how markets view the cloud observability firm.
Including today’s gains, Datadog stock is up more than 70% versus its year-to-date low in April.
S&P 500 inclusion could unlock upside in Datadog stock
Inclusion in the S&P 500 forces billions of dollars in passive assets, including exchange-traded funds (ETFs) and mutual funds, to buy DDOG shares to mirror the index composition.
That means automatic demand, elevated trading volume, and tighter spreads.
Index inclusion often improves the overall sentiment toward a stock since investors tend to read it as validation of the company’s strong and growing financials.
In fact, companies added to the S&P 500 historically experience a 5 – 15% increase in their stock prices between the announcement and the effective date.
This signals potential for further near-term gains in DDOG stock.
As for the longer term, joining the ranks of America’s most influential companies is just as exciting for Datadog investors, given it will now gain broader analyst coverage, institutional visibility, and a more diversified shareholder base.
DDGO shares remain attractive due to financial strength
Datadog stock is worth owning for the strength of the company’s financials as well.
In Q1, the cloud company reported a better-than-expected year-over-year increase in both profit and revenue as the number of customers with an annual run rate of at least $100,000 popped further to 3,770.
DDOG also issued encouraging guidance for the full year in May. “We’re innovating rapidly to help customers observe, secure, and act to solve mission-critical business problems in modern, cloud environments,” Olivier Pomel, the company’s chief executive, told investors at the time.
That said, DDOG shares remain unattractive for income investors as they do not currently pay a dividend.
Should valuation be a concern in owning Datadog Inc?
Despite a meteoric rally over the past three months, Datadog shares remain relatively cheaper to own on a price-to-sales basis compared to its cloud peers, including ServiceNow and Snowflake Inc.
DDOG currently has a P/S ratio of about 17 only, versus 19 for ServiceNow and an even higher 20 for SNOW.
However, a smarter way to build a position in DDOG stock would be to wait for a pullback since it’s already trading at a price well above Wall Street’s average price target.
While the consensus rating on the cloud stock remains a “strong buy,” the mean target of $140 actually indicates potential “downside” of more than 5.0% from current levels.
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