This Artificial Intelligence (AI) Stock Looks Like a Top Buy Following Its Latest Pullback

Cloud computing platform provider DigitalOcean (NYSE: DOCN) has had a forgettable year on the stock market so far. The stock sank 10% after DigitalOcean released its third-quarter results on Nov. 4. And so far in 2024, the shares are up just 7%.

But it looks like the market is underestimating the cloud computing provider's immense growth potential and the healthy results that it has been delivering of late. A closer look at the company's results will tell us that its recent performance didn't deserve such a sell-off.

Let's look at the reasons why.

DigitalOcean is growing at a healthy pace, and AI could give it a nice lift

DigitalOcean's revenue in the third quarter of 2024 increased 12% year over year to $198 million, while its adjusted earnings grew 18% from the same quarter last year to $0.52 per share. The company's top line exceeded its guidance range of $196 million to $197 million, while the bottom line was significantly higher than the $0.40 per share earnings estimate.

Even better, DigitalOcean raised its full-year guidance. It expects to finish the year with $776 million in revenue now as compared to the earlier expectation of $772.5 million. Non-GAAP (adjusted) earnings are now expected to land between $1.70 per share and $1.75 per share as compared to the prior expectation of $1.60 per share to $1.70 per share.

So, it was perplexing to witness a sell-off in DigitalOcean stock following its beat-and-raise quarter, especially considering that the company's focus on offering cloud-based artificial intelligence (AI) solutions should help it win a bigger share of customers' wallets. DigitalOcean's cloud computing platform is used by start-ups, developers, and small and medium-sized businesses, with the company providing both infrastructure-as-a-service (IaaS) and platform-as-a-service (PaaS) solutions.

Customers use DigitalOcean's platform to build, scale, and deploy applications while also purchasing networking, compute, and storage services from the company. And now, DigitalOcean is also offering virtual machines powered by Nvidia's popular H100 graphics processing units (GPUs) through a service known as GPU Droplets.

This is an on-demand service with which customers can access DigitalOcean's GPU infrastructure for training and deploying AI models, data analytics, deep learning, and high-performance computing. DigitalOcean says that this on-demand offering can be accessed at $2.99 per GPU per hour, and customers can scale up as and when required.

GPU Droplets allows users to create chatbots, train large language models (LLMs), and generate images and video, among other things. What's more, DigitalOcean recently launched a generative AI product known as GenAI Platform, which will allow users to build AI agents with the help of its GPU infrastructure. The company is giving customers access to popular models such as Llama 3.1 and Mistral NeMo through this offering, which customers can use to create customized AI agents using their proprietary data.

These are smart moves made by DigitalOcean to tap the fast-growing AI market. Its customers won't have to break the bank to train and deploy AI models as the company is offering them access to powerful GPUs while also enabling them to create and customize applications with the help of foundational models.

The good part is that this strategy seems to be driving an increase in spending by customers. The company's average revenue per user (ARPU) increased an impressive 11% year over year in the third quarter of 2024 to $102.51. It is worth noting that DigitalOcean's ARPU has been ticking up as the year has progressed, jumping from $95.13 in Q1 to $99.45 in Q2 and into triple digits last quarter.

It won't be surprising to see this trend continuing in the future as the company is expecting a healthy increase in its market opportunity going forward. DigitalOcean points out that cloud spending by individuals and companies with less than 500 employees could come in at $114 billion in 2024 and grow at an annual rate of 23% to $213 billion in 2027.

The integration of AI tools within its cloud computing platform could help accelerate its growth and lead to an improved growth outlook going forward, which is why it may be a good idea to buy the stock right now.

Why you should consider buying this stock now

DigitalOcean is currently trading at 21 times forward earnings, which means that it can be bought at a discount to the tech-heavy Nasdaq-100 index's forward earnings multiple of nearly 30. Buying this AI stock at this valuation could turn out to be a smart move as the company's earnings growth rate is expected to improve going forward.

DigitalOcean's 2024 earnings estimate points toward a potential jump of 8.5% from 2023's reading of $1.59 per share. However, the forecast for the next couple of years suggests that its bottom-line growth will eventually accelerate into double digits in 2026.

DOCN EPS Estimates for Current Fiscal Year data by YCharts

Moreover, consensus estimates are projecting DigitalOcean's earnings to grow at an annual rate of almost 14% for the next five years, though it won't be surprising to see the company do better than that, thanks to a new catalyst in the form of AI. So, investors looking to buy a tech stock that's trading at an attractive valuation and could get an AI-powered boost, in the long run, should consider taking a closer look at DigitalOcean following its latest pullback.

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Harsh Chauhan has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends DigitalOcean and Nvidia. The Motley Fool has a disclosure policy.