When you look back in 5 years, you'll wish you'd bought this small artificial intelligence (AI) stock.

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DigitalOcean is competing with Amazon, Microsoft, and Alphabet in the cloud computing space.

Years ago, businesses would collect customer and operational data and store it on physical servers on site. Today, they rent hardware capacity from centralized data centers for much more than a fraction of the cost, a practice called cloud computing.

Data center operators like Amazon web services, Microsoft Azure, and the alphabetGoogle Cloud dominates the cloud industry. Their services go beyond simple data storage to include hundreds of different solutions designed to help businesses thrive in the digital age, and a growing number around artificial intelligence (AI). Centered around.

Digital Ocean (DOCN -1.60%) is another cloud computing company, except that it focuses specifically on serving small and medium-sized businesses (SMBs). It is now expanding into AI to give its customers access to the technology at an affordable cost. This could be an incredible growth opportunity, so investors here may be glad they bought DigitalOcean stock when they look back on this moment in five years.

Image source: Getty Images.

DigitalOcean is diving into AI.

Amazon, Microsoft, and Alphabet are trillion-dollar companies, so their cloud divisions are incredibly well-resourced. However, this also means that catering to small businesses won't really move the needle in terms of revenue, so they prefer to focus on larger enterprises that can afford to spend millions of dollars on cloud services. are DigitalOcean, on the other hand, is only valued at $3.5 billion, so it gets a lot of value from startups and businesses with fewer than 500 employees.

DigitalOcean offers these customers personalized support, affordable and transparent pricing, and simple functionality because it recognizes that many of them do not have in-house technical teams. It also offers a relatively narrow portfolio of services tailored to its target market, which streamlines its cost structure and keeps prices affordable.

Last year, DigitalOcean bought Paperspace, a startup that manages data centers geared toward AI developers, for $111 million. It provides some of the industry's leading semiconductor hardware, including the H100 GPU Nvidiayet its prices are up to 70% cheaper than cloud giants like Microsoft Azure.

Like DigitalOcean, Paperspace has a low cost structure because its product offering is extremely narrow, and those savings are passed on to the small-scale developers it serves. By combining the two companies, customers get a comprehensive solution that covers all of their cloud and AI needs, which they might not have been able to afford if they used leading cloud providers.

Paddy Srinivasan, DigitalOcean's chief executive officer, says demand for its AI GPU compute capacity will outstrip supply in the near future. In fact, while it's still early days, the company's annual revenue for AI services grew at an annualized rate of 128% in the three months between December 2023 and March 2024.

DigitalOcean's revenue growth has slowed recently, but for a good reason

DigitalOcean generated revenue of $184.7 million during the first quarter of 2024. This was a record high, but it represented only 12% growth from the year-ago period. During 2022, the company's revenue grew by more than 30 percent as normal, but growth slowed in 2023 as management shifted its focus.

Like most tech companies, DigitalOcean operated with a cost-at-every-cost strategy, which meant investing heavily in sales, marketing, and research and development, even if it resulted in a net loss. . However, since interest rates start to rise in 2022, companies like DigitalOcean have shifted their focus to capital preservation, which means cutting costs to deliver profits.

During Q1, DigitalOcean reduced its operating expenses by 20% compared to the year-ago period, leading to net income of $14.1 million. This was a positive swing from the $16.3 million net. loss It was delivered in the same quarter of 2023.

Simply put, slowing income growth is certainly not a good thing in isolation. However, in an uncertain economic environment where debt is expensive and raising fresh equity capital can be difficult, a company's best bet is to protect its cash. Most analysts believe the US Federal Reserve will start cutting interest rates in 2024, which should boost economic activity. When favorable conditions finally prevail, DigitalOcean can easily turn its attention to growth.

Why DigitalOcean Stock is a Buy Now

The addressable market for DigitalOcean SMB cloud services is valued at $114 billion annually, which could nearly double to $213 billion by 2027. The company estimates that it will bring in $775 million in revenue this year, so it's barely scratched the surface. of this occasion.

But AI can significantly increase the value of the digital ocean's detectable market. PwC estimates the technology will add $15.7 trillion to the global economy by 2030, and Cathy Wood's Arc Investment Management believes AI software companies could generate $14 trillion in revenue by then. There's no telling if these predictions will hold true in the long run, but applications like ChatGPT are already increasing productivity thanks to the ability to instantly generate text, images, videos, and computer code.

DigitalOcean (with help from Paperspace) is a pick-and-shovels game at this point. Its data center infrastructure and cloud platform are the tools SMBs need to participate in the AI ‚Äč‚Äčrevolution, and as the company's CEO said, demand is already outpacing supply.

DigitalOcean stock is trading about 70% below its all-time high, set during the tech frenzy in 2021. Its valuation was a bit unrealistic at the time, but investors have also punished the company for its sluggish earnings growth of late. However, this could present a golden buying opportunity for investors with an investment horizon of at least five years, as AI could become a key contributor to DigitalOcean's business by then.

Suzanne Frey, an Alphabet executive, is a member of The Motley Fool's board of directors. John Mackey, former CEO of Whole Foods Market, is a member of the board of directors of The Motley Fool, an Amazon subsidiary. Anthony DiPizio has no position in any stocks. The Motley Fool has positions and recommends Alphabet, Amazon, DigitalOcean, Microsoft, and Nvidia. The Motley Fool recommends the following options: long January 2026 $395 calls on Microsoft and short January 2026 $405 calls on Microsoft. The Motley Fool has a Disclosure Policy.

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