DigitalOcean(NYSE: DOCN) has long provided cloud services to small and mid-sized businesses (SMBs). Now, it's also bringing a suite of artificial intelligence (AI) offerings to those customers, providing them with affordable access to this revolutionary technology.
The stock is trading 71% below its all-time high from 2021. It was unquestionably overvalued at the time, but that steep decline, combined with the company's significant addressable market, make for an attractive opportunity from here.
When investors look back on this moment in the future, they might wish they had bought the stock on the dip. Here's why 2025 could be DigitalOcean's biggest year to date.
Bringing AI to small businesses
The cloud computing industry is dominated by three players: Amazon Web Services (AWS), Microsoft Azure, and Alphabet's Google Cloud. Each service is supported by its trillion-dollar parent company, which is a key reason they've quickly become the top destinations for businesses seeking AI services like data center computing capacity and ready-made large language models (LLMs).
DigitalOcean specifically focuses on serving start-ups and SMBs with under 500 employees. Those segments of the cloud and AI markets don't move the needle for the aforementioned industry titans, which instead target larger organizations with bigger budgets.
DigitalOcean has created a friendly environment for its SMB cloud customers by offering clear and transparent pricing, highly personalized service, and tools that are extremely easy to deploy -- features ideal for enterprises with limited financial resources. It's taking the same approach to AI services. Last year, DigitalOcean became one of the first platforms to offer fractional computing capacity, allowing SMBs to access between one and eight of Nvidia's industry-leading data center graphics processors (GPUs).
Providers like AWS and Azure regularly advertise their ability to offer AI data center clusters featuring tens of thousands of GPUs to serve the most ambitious developers, so they aren't targeting the smaller end of the market. DigitalOcean's fractional capacity ensures that even the smallest businesses have an opportunity to benefit from AI.
The company said its AI-related annual recurring revenue soared by more than 200% year over year in Q3 2024. That's a sign of solid demand. The company will report its fourth-quarter results in February, so investors should look out for another update on that front.
Image source: Getty Images.
DigitalOcean's highest-spending customer cohort is growing the fastest
DigitalOcean has over 638,000 customers, and it breaks them into three main categories:
Learners: DigitalOcean has 474,000 of these customers, which are typically in the start-up phase and spend an average of just $15 per month on cloud and AI services.
Builders: The 145,000 customers in this group are in the growth phase of their business life cycle. They typically spend $145 per month, on average.
Scalers: This cohort is the smallest at 18,000, but they are the most valuable because they spend an average of $2,153 per month. These businesses have graduated from the start-up phase and might already have solid revenue.
Despite accounting for just 2.8% of DigitalOcean's total customer base, Scalers represent a whopping 58% of the company's total revenue. Plus, as of September last year, annual recurring revenue from the Scalers cohort grew 19% year over year, which was a much faster increase than the other two customer groups.
That's a great sign. Almost any company would want to see its highest-spending customers growing the fastest since they bring in most of the revenue.
According to DigitalOcean's guidance, its full-year results for 2024 (to be announced in February) are likely to show a record $776 million in total revenue. It would be a relatively modest increase of 12% from 2023, partly because the company has carefully managed its costs (like marketing) in order to improve its bottom line.
DigitalOcean shrank its total operating expenses by 4% year over year during the first three quarters of 2024, resulting in net income of $66.2 million. That was a 19-fold increase from the year-ago period, and it gives the company more flexibility to reinvest in future growth.
DigitalOcean stock is attractively valued right now
DigitalOcean stock was incredibly expensive (and unprofitable) when it peaked in 2021 with its price-to-sales (P/S) ratio soaring to 30. The 71% decline in the stock, combined with the company's solid growth since then, have pushed its P/S ratio down to a far more reasonable level of 4.7.
That is actually a 43% discount to its lifetime average P/S ratio of 8.3, dating back to when DigitalOcean first went public:
DigitalOcean's addressable market in cloud services for SMBs was worth an estimated $114 billion in 2024, but the company thinks that number could grow to $213 billion by 2027. That doesn't include AI services -- which, if the recent results from cloud giants like AWS are any indication, could become a substantial contributor to DigitalOcean's revenue in the coming years.
The S&P 500 stock market index is trading at record highs and is historically expensive, so finding value isn't easy right now. That's why DigitalOcean stock presents an attractive opportunity, especially for investors seeking a unique way to play the AI revolution.
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John Mackey, former CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. Anthony Di Pizio has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Alphabet, Amazon, DigitalOcean, Microsoft, and Nvidia. The Motley Fool recommends the following options: long January 2026 $395 calls on Microsoft and short January 2026 $405 calls on Microsoft. The Motley Fool has a disclosure policy.
