DigitalOcean (NYSE:DOCN) and Upstart (NASDAQ:UPST) have both seen astronomical growth over the past six months — with share prices jumping 118% and 190% respectively. While that might scare some investors, I believe that winners keep winning, and these two stocks are definitely winners.
With one company recently reporting earnings and the other reporting earnings on Nov. 9, now is a good time to evaluate whether it would be worth it to invest $500 into either of these two companies. DigitalOcean reported strong results, and Upstart has the potential to do the same. Let’s look at why these two winners are worth a closer look.
DigitalOcean: Taking on giants
DigitalOcean is trying to help small- and medium-sized businesses (SMBs) develop cloud infrastructure easily. The company is taking on big cloud behemoths like Amazon (NASDAQ:AMZN) Web Services (AWS) and Microsoft (NASDAQ:MSFT) Azure. While those companies mainly focus on enterprise-level operations, DigitalOcean focuses on SMBs. SMBs normally do not need as many tools as enterprises do, so AWS and Azure platforms tend to be unnecessarily complicated.
DigitalOcean’s focus on simplicity and price transparency has led to its small offering of basic, core tools for SMBs and independent developers. Its offering focuses on a few critical cloud-based applications like managed databases, droplets, and app platform building, which are typically all that SMBs need. This has led to the company dominating its space, serving almost 600,000 customers in the third quarter, a 7% increase from the prior-year quarter.
The company reported strong results in Q3, announcing revenue of $111 million, which was a 37% jump year over year. Its average revenue per user increased 28% to $62, and the company’s net retention rate reached 116%. This is impressive for a customer base of SMBs, which are naturally more likely to churn because of their smaller budgets.
This net retention rate was higher than ever before and grew 1,200 basis points year over year, which might have contributed to the company’s net loss improving from a $10 million loss in Q3 2020 to a net loss of $1.9 million in Q3 2021.
DigitalOcean does not come without risk, however. Its competition from heavyweight cloud providers like Amazon and Microsoft is an obvious risk, and the company will have to balance the benefit of simplicity it brings while expanding its offering. This challenge will be difficult, but so far the company has done a very good job strategically adding new offerings to expand its relationship while keeping its platform simple.
The stock is priced at 25 times sales, but its ability to keep Amazon and Microsoft on the ropes is very impressive. DigitalOcean sees its addressable market increasing 27% annually to reach $116 billion by 2024. If it can continue dominating the SMB market, this company has room to explode, which is why I think it is a smart stock to buy today.
Upstart: Starting a credit revolution
In a world where Fair Isaac‘s (NYSE:FICO) FICO credit score rules all, Upstart is trying to revolutionize how consumers get loans. Upstart does not solely rely on the FICO score, but rather on a diverse set of data points ranging from employment to the time it takes for customers to view the application to determine creditworthiness. Often, a consumer’s credit score is bad because of one slip-up, or they have no score at all. With FICO, these consumers might not be able to access good credit, but Upstart is trying to change that.
The primary risk with Upstart has been its revenue sources. Customer concentration was high at the end of 2020, with one lender accounting for 67% of its loan volume. Since the start of the year, however, Upstart has rapidly been attracting additional customers and diversifying its revenue stream. In Q2 of 2021, its biggest client only represented 60% of Upstart’s loan volume. That percentage share will likely drop further in Q3 as the company has added five new bank partners since it reported its Q2 earnings.
Upstart does not actually fund the loans it approves — it provides banks with determinations of creditworthiness for a fee. This allows for Upstart to generate a contribution profit of $96.7 million, which represents a margin of 52% on its Q2 revenue of $194 million. Looking at Q3, the company expects revenue to increase 8% sequentially to $210 million and net income to decrease sequentially from $37 million in Q2 to $20 million. The company is also expecting the Q3 contribution margin to decrease to 45%. Both net income and margin declines are because Upstart management wants to focus on reinvestment and growth more than on profitability.
While the company might take a hit on profits this quarter, it is to be expected. If the stock falls because of it, I will be looking to add to my position in the stock. At a valuation of 60 times sales, the company is priced for perfect Q3 execution, but I think that Upstart will be up to the task.
Since coming public, the company has done nothing but execute, which is why the high valuation is worth paying for. Upstart is a smart place to park $500 and watch it grow for the next five or 10 years.
This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.