Incorporate an Artificial Intelligence (AI) Investment Option as Your 2025 New Year's Commitment in Your Portfolio

Incorporate an Artificial Intelligence (AI) Investment Option as Your 2025 New Year's Commitment in Your Portfolio

With less than two months left in 2024, now is a perfect time for investors to consider which stocks they'd like to keep for 2025. Currently, artificial intelligence (AI) seems set to be a major trend in the market in 2025, so it might be wise to start by looking at companies that operate in this sector.

DigitalOcean (DOCN 0.70%) is a mid-sized company providing cloud computing services, with a particular focus on small and medium-sized businesses (SMBs). However, it also offers a range of AI services, including advanced data center infrastructure equipped with top-of-the-line chips from Nvidia.

DigitalOcean's stock is currently trading at one of its cheapest levels as a public company, according to a common valuation metric, making it an attractive investment option.

Treading in Giant Footsteps

Amazon Web Services, Microsoft Azure, and Alphabet's Google Cloud are the leading providers of global cloud services. But how does a company like DigitalOcean, with a market cap below $4 billion, compete with these multibillion-dollar giants?

DigitalOcean focuses on a niche market not serviced by the megacaps - businesses with fewer than 500 employees, especially start-ups that often can't afford in-house technical staff. The cloud industry leaders mostly target larger enterprises because they have more substantial budgets.

DigitalOcean offers affordable pricing, personalized service, and straightforward deployment tools, making it an excellent fit for SMBs. In fact, 474,000 of DigitalOcean's 638,000 customers spend an average of $15 per month with the company. The hope is that some of them will eventually grow into "scalers" - customers who spend an average of $2,153 per month with DigitalOcean.

Currently, DigitalOcean has around 18,000 of these "scalers" on its client list, contributing to over half of its monthly revenue.

DigitalOcean is joining the AI race

Last year, DigitalOcean acquired Paperspace, an operator of data centers specifically tailored for AI developers. Paperspace provides per-second billing and no long-term contracts, making it an attractive option for SMBs looking to deploy AI. Its services are even up to 70% cheaper than identical options from Microsoft Azure.

Leading cloud providers offer AI developers access to servers equipped with thousands of GPUs from suppliers like Nvidia. However, SMBs typically don't require this level of computing power. Recognizing this, DigitalOcean recently announced it would allow its customers to access fractional GPU capacity. Customers can pay to use between one and eight Nvidia H100 GPUs, providing even small businesses the chance to deploy some AI-supported systems.

Fractional GPU capacity is relatively uncommon in the industry, and it's unlikely that cloud giants like Microsoft and Amazon will attempt to compete at this small scale. This gives DigitalOcean a significant advantage in this particular market, and demand is surging.

During the third quarter, DigitalOcean reported $198.5 million in total revenue, a 12% increase from the previous year. However, its AI revenue specifically increased by nearly 200%.

DigitalOcean stock appears undervalued right now

DigitalOcean began generating consistent quarterly GAAP profits only last year, so it may be too soon to value its stock based on the traditional price-to-earnings (P/E) ratio. However, it has generated $0.87 in trailing 12-month earnings per share (EPS), giving it a P/E ratio of 44.2 based on its current stock price of $38.50.

This seems expensive compared to the tech-heavy Nasdaq-100 index, which currently has a P/E ratio of 33.1. However, DigitalOcean's EPS increased by an astounding 1,650% year over year in the first nine months of 2024. If this trend continues, the stock will likely look cheaper on a P/E basis sometime in 2025.

The price-to-sales (P/S) ratio might be a better way to assess this company's value right now. Based on DigitalOcean's trailing 12-month revenue of $756.6 million and its current market capitalization, its stock trades at a P/S ratio of 4.8. This is nearly its cheapest level since it went public in 2021 and represents a 43% discount to its lifetime average P/S ratio of 8.5.

According to market intelligence firm IDC, the cloud market for SMBs is currently worth $114 billion annually. DigitalOcean has barely tapped into this market's potential. IDC also forecasts that this segment will grow to $213 billion by 2027, but the AI revolution could inflate this figure into the trillions. Depending on the Wall Street forecast, AI could add between $7 trillion and $200 trillion to the global economy in the coming decade, and DigitalOcean stands a chance to capture a significant portion of the SMB market.

Investors seeking a new AI opportunity to add to their portfolio and carry into 2025 should certainly consider DigitalOcean.

Given the current market trend towards AI and DigitalOcean's acquisition of Paperspace, which offers affordable AI services, this could be an excellent opportunity for investors interested in the finance and technology sectors to invest in DigitalOcean's stock. The company's focus on small and medium-sized businesses and its strategy of providing fractional GPU capacity make it a unique player in the market, potentially positioning it for significant growth in the coming years.

As DigitalOcean reported a 200% increase in AI revenue in the third quarter and has a market cap below $4 billion, it might be an undervalued investment option for those looking to capitalize on the potential increase in demand for AI services in the coming years.

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