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Businesses require more than just semiconductors and foundation models to successfully deploy artificial intelligence (AI) software. They also need observability tools to track development costs, and to ensure their AI applications are producing appropriate outputs.
Datadog (NASDAQ: DDOG) is an observability specialist, and it has an expanding portfolio of products designed specifically for the AI industry. Its stock soared to a record high of $293.26 last month, but it has since declined by 40% (as of the market close on Nov. 5) amid deteriorating investor sentiment toward the AI industry as a whole.
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However, Wall Street thinks this is a golden buying opportunity. The majority of the analysts tracked by The Wall Street Journal have given Datadog stock a buy rating, and their average price target implies significant upside from here. Their bullish stance might be justified, but the stock's valuation could stand in the way of meaningful upside in the near term.
Datadog's cloud observability platform helps businesses monitor their digital infrastructure, so they immediately know when a technical issue disrupts a critical piece of software or a sales channel. This allows managers to fix the problem before it impacts employees and customers.
Datadog's growing portfolio of AI products helps businesses monitor their entire AI stack in the same way. For example, Agent Observability tracks an organization's active AI agents, evaluating their token usage (costs), speed, and the quality of their outputs.
Then there is GPU Monitoring, which helps businesses track costs, usage, and technical issues when deploying data center graphics processing units (GPUs). These are the main chips used in AI training and inference workloads, so their operational health is essential for keeping agents and other software applications running smoothly.
Datadog had 33,500 customers at the end of the third quarter of 2026 (ended Sept. 30), and one-third of them were using at least one of the company's AI products. Datadog said it now serves 850 AI-native enterprises, including all 15 out of the industry's 15 leading AI companies. It didn't name them specifically, but we can safely assume they include labs like OpenAI and Anthropic.
Moreover, agentic AI activity is soaring across the Datadog ecosystem. The company says Model Context Protocol (MCP) calls have grown by a factor of 50 so far this year, which simply means customers are using AI agents to perform more tasks than ever before.
Datadog generated $1.2 billion in revenue during the third quarter, a 35% increase from the year-ago period. The result was so strong that management increased its full-year revenue guidance for 2026 by $60 million, and now expects the company could bring in $4.52 billion (at the midpoint of the forecasted range).
Datadog's third-quarter revenue grew at a much faster pace than its operating expenses, which increased by 24% year over year. As a result, more money flowed to the bottom line, resulting in a generally accepted accounting principles (GAAP) net income of $118.3 million, up 249%.
Moreover, after excluding one-off and non-cash expenses like stock-based compensation, Datadog delivered an even higher adjusted (non-GAAP) net income of $304.3 million, up 54% year over year.
Simply put, Datadog's ability to generate strong revenue growth without significantly ramping up growth-oriented expenses like marketing suggests it's experiencing a lot of organic demand for its products, and its AI portfolio is a big reason why.
The Wall Street Journal tracks 50 analysts who cover Datadog stock, and 39 have given it a buy rating. Seven others are in the overweight (bullish) camp, while three recommend holding, and just one recommends selling.
The analysts have an average price target of $274.16, suggesting the stock could return 41% over the next 12 months or so. The Street-high target of $330 implies the stock could soar by 89% instead.
Datadog's valuation might stand in the way of Wall Street's forecasts. Its stock is trading at a price-to-sales (P/S) ratio of 16.1, making it significantly more expensive than the Nasdaq-100 index which has a P/S ratio of 5.8. In other words, Datadog looks heavily overvalued compared to a group of America's highest-quality technology companies.
In fact, although Datadog is unique with very few direct competitors in the public markets, it's far more expensive than a basket of other individual cloud and AI software names.
Therefore, I think investors hoping Datadog hits Wall Street's price targets over the next 12 months might be left disappointed. The stock has upside potential over the long term, but I think holding it for at least three years will be key.
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Anthony Di Pizio has positions in Atlassian. The Motley Fool has positions in and recommends Alphabet, Atlassian, Datadog, and Microsoft. The Motley Fool has a disclosure policy.
1 Growth Stock Down 40% to Buy Hand Over Fist in November, According to Wall Street was originally published by The Motley Fool
