3 Recent IPOs to Watch in 2020

Investing in small new companies is always a gut-wrenching endeavor requiring discipline and patience -- 2019 was proof of that. In a tale of two markets, IPOs could seemingly do no wrong through the first half of the year as investors greeted them with open arms and asked few questions. The resulting inflated valuations on many of these stocks reversed course starting in the autumn, though, with many recent IPOs now back near or under their public debut pricing.

If some of these upstart firms can maintain their growth, though, now would be a good time to test the waters and make some small purchases. Three I have my eye on at the start of 2020 are Datadog (DDOG +1.86%), Cloudflare (NET +2.08%), and CrowdStrike (CRWD +2.21%).

YOY = year over year. PP = percentage point. Crowdstrike data for nine-month period ending Oct. 31, 2019. Data source: Datadog, Cloudflare, and Crowdstrike.

A big year for data analytics

With big data becoming more useful as organizations around the globe make the switch to cloud-computing based operations, data analytics firms have enjoyed resurgent growth and renewed interest from investors in the last year. This trend didn't go unnoticed by Alphabet's Google and salesforce.com, which both made big data analysis acquisitions early in 2019. In the wake of the boom, newcomer Datadog also decided to take itself public to raise some cash as it expands.

While the newly-minted stock did get hit shortly after its debut, shares have since rallied, and it is one of a select group of IPOs from the 2019 class that still trades near or above its opening price when the stock became available to the general public. That is thanks in large part not just to the company's 83% growth rate through the first three quarters of 2019 but also the fact that those results are accelerating. Third-quarter revenue notched an 88% increase, annual customer contracts valued over $100,000 grew to 727 compared with only 377 a year ago, and the company is narrowing in on adjusted profitability (when backing out non-cash expenses like stock-based compensation).  

There's a clear path forward as well. Datadog recently announced well over a dozen new capabilities available on its platform, including security monitoring and network performance monitoring. It's also well capitalized to support its growth, with $761 million in cash and short-term investments on the books at the end of the third quarter. Thus, it can sustain its current rate of losses for years as the company maximizes its growth potential in the short term.  

Of course, this kind of growth that's already nearing a profitable scale doesn't come cheap. Datadog trades for over 31 times sales based on full-year 2019 revenue expectations. That's the only thing that has held me back from making a purchase so far, as that sky-high valuation implies the company can sustain its momentum for quite some time. With ample competition out there, there's a decent chance Datadog loses some steam. If it does and shares take a tumble, I'm a buyer.

Image source: Getty Images.

A diversified cloud services provider

While going after big contracts has been the strategy for many new tech outfits, diversified cloud company Cloudflare has attacked the market from the other end of the spectrum. During the company's first public earnings call in Nov. 2019, management discussed Cloudflare going after early adopters and small businesses with new products (some of them offered for free), gathering feedback, and then moving upstream from there. In an increasingly crowded field of software providers, it's a refreshingly different take -- and perhaps a smart one if results thus far can be repeated.  

At the end of the third quarter, Cloudflare said it had over two million customers across its free and paid platform. As it further refines its services, it is picking up speed signing on bigger paying customers, reporting a 71% year-over-year increase in that metric. That led to a 48% increase in revenue and an improving gross profit margin of 78.9% -- increasing its full-year total and helping narrow the gap to adjusted profitability.

Those are all good things an investor wants to see in a fast-growing start-up, and results seem primed to continue rolling higher as Cloudflare releases new products and features -- from web content delivery services to security to app development. Therein lies another potential positive in Cloudflare's favor: In a world where options abound and managing digital operations is increasingly complex, simplifying things with fewer vendors makes sense for a lot of businesses. Cloudflare can check a lot of boxes for its customers.  

Shares are slightly down from their opening levels when the stock began trading in September, and as of this writing, they command a valuation of about 18 times expected 2019 sales. It's still a hefty premium but not out of the question if Cloudflare's growth momentum can continue.

A fast-changing cybersecurity industry

Speaking of cybersecurity, CrowdStrike was one of the year's hottest IPOs before coming back down to earth again once investors realized triple-digit revenue growth wasn't in the cards anymore. However, the 94% growth reported so far in 2019 is nothing to balk at, nor is the at least 86% rate for the full-year period forecast by management.  

Behind CrowdStrike's torrid expansion is the massive proliferation of network-connected devices, which are expected to continue growing by hundreds of millions annually over the next few years. CrowdStrike's security platform can secure those devices -- known as endpoints in industry parlance, and which cover everything from consumer products like smartphones and laptops to enterprise-grade sensors like security cameras and industrial equipment. Additionally, the company is leveraging its runaway success in securing endpoints to get into adjacent cybersecurity markets like its recently announced firewall management application and an investment fund aimed at supporting start-ups utilizing the CrowdStrike platform and security app store.  

As with Cloudflare, CrowdStrike's gross profit is on the rise as it adds more customers, and operating expenses are also growing more slowly than revenue is. While net losses are still mounting for now, the company was actually free-cash-flow positive (money left over after basic operating and capital expenses are paid for) in its fiscal third quarter, running a $7 million surplus. While top-line expansion remains priority number one, this security firm's early success in turning the corner on operating in the black is promising.

Of course, just like the other two recent IPOs on this list, investors are really left with price-to-sales metrics to value shares, and based on full-year expectations, CrowdStrike's ratio of 22 still isn't cheap even after the stock backtracked from nearly $100 per share to current levels around $50. However, valuation should continue to moderate over time if it can keep even half of its recent momentum.

Datadog, Cloudflare, and CrowdStrike have all been volatile stocks from the 2019 IPO class, but they could continue to put up solid numbers in 2020. These are three stocks worth watching -- if not worth nibbling on -- in the year ahead.