From e-commerce to cloud computing, digital transformation (DX) promises to cut costs, boost productivity, and improve the customer experience. That's why businesses are spending money hand over fist to keep pace with technology. In fact, the International Data Corp. estimates that DX spending will grow at 22% per year through 2024, reaching $2.4 trillion. That creates an enormous opportunity for investors.
PagerDuty (NYSE:PD), which often flies under the investment community's radar, plays an important role in helping businesses adopt and manage their digital technologies. And if PagerDuty can accelerate customer growth, I wouldn't be surprised to see this mid-cap stock deliver 10x returns over the next decade.
Let's find out a bit more about this company.
The tailwinds of digital transformation
Digital transformation has made the IT ecosystem more complex. Not surprisingly, the number of business-critical incidents and outages is increasing, and each of those events has the potential to reduce employee productivity and damage an organization's reputation with customers. To mitigate that risk, PagerDuty helps nearly 18,000 businesses keep their digital technologies up and running.
Specifically, its platform collects and correlates data from across the IT ecosystem, including monitoring tools like Datadog, cloud infrastructure like Amazon, and security software like Okta. PagerDuty then leans on artificial intelligence to predict and automatically prevent performance issues. Or if the problem can't be resolved through automation, it orchestrates a response by alerting the appropriate teams. The platform also provisions those teams with relevant data.
Ultimately, that translates into fewer incidents and less downtime. And as DX has become a top priority for modern enterprises, PagerDuty's value proposition has only become more compelling. Management now puts its addressable market at $36 billion.
The benefits of being a first-mover
PagerDuty is a pioneer in digital operations management, and over the last decade, it has established itself as an industry leader. Currently, its platform integrates with over 600 technologies, more than any other solution on the market. Its AI models are powered by nearly 12 years' worth of data, and every new data point makes the platform better at predicting and preventing problems
PagerDuty has turned that advantage into strong demand. Its platform powers over 65% of the Fortune 100 and 45% of the Fortune 500, and its customer list includes well-known brands like Salesforce and Square. More importantly, PagerDuty's renewal rate exceeds 95%, meaning very few customers are churning, and the average customer spent 26% more over the past year.
In both cases, those metrics demonstrate the stickiness of the PagerDuty platform, and that has helped the company grow its top line quickly.
Metric |
Q2 2020 (TTM) |
Q2 2022 (TTM) |
CAGR |
|---|---|---|---|
Revenue |
$142.7 million |
$244.2 million |
31% |
Source: YCharts. TTM = trailing 12 months. CAGR = compound annual growth rate. Note: Q2 2022 ended July 31, 2021.
As a caveat, investors should be aware of two potential concerns: First, PagerDuty is investing aggressively in growth, so operating costs are rising quickly. As a result, the company generated a negative free cash flow of $6.4 million over the last 12 months. That being said, it has $547 million in cash and investments on its balance sheet and just $280 million in long-term debt. That means PagerDuty can afford to burn cash for a while.
Second, and perhaps more concerning, customer growth decelerated to 6% in the latest quarter. That number needs to reaccelerate if PagerDuty hopes to scale its business and achieve profitability. Investors should pay close attention to that metric in the coming quarters.
The case for 10x returns
Despite the risk, PagerDuty looks like a compelling long-term investment. The company helps organizations adopt a proactive incident response strategy, which makes it possible to resolve issues in minutes, rather than hours or days. And as DX continues to reshape the IT ecosystem, PagerDuty could see supercharged growth in the coming years.
On that note, the stock currently trades at a reasonable 12.4 times sales, and PagerDuty's market cap sits at just $3.1 billion. If the company can maintain revenue growth of 26% annually over the next decade, its market cap could grow tenfold without any change in the price-to-sales ratio. And if the company can accelerate its customer growth, I think that scenario is entirely plausible.
That's why this growth stock looks like a smart buy for risk-tolerant investors.