I like to make a small starter investment in a stock and add to the position as my conviction grows. Two stocks I’ve been buying hand over fist to increase my allocation over the past few months are Alphabet (GOOG) (GOOGL) and Datadog (DDOG). They have tremendous growth prospects, positioning them to potentially produce market-crushing returns in the coming years.

Gobbling up more shares of Google’s parent
After years of holding out, I finally added Google’s parent, Alphabet, to my portfolio during the depths of the pandemic-driven market meltdown in early 2020. I wanted to keep adding to that position, but shares bounced back sharply. However, I got another chance to add as they started selling off last year. I’ve since boosted my position a couple of times and will continue buying shares if they remain at or below their current level.

One thing I love about Alphabet these days is that it’s trading near its lowest valuation levels in the last decade.

Alphabet trades at its lowest price-to-earnings (PE) ratio in 10 years and around its cheapest price-to-free cash flow level since 2017. That’s an unbelievable level for a company with Alphabet’s growth profile.

Its consolidated revenue was up 6% in the third quarter to $69.1 billion (and rose 11% on a constant currency basis). While its earnings declined because of higher expenses, most was due to increased research and development and sales and marketing spending to drive future growth.

Meanwhile, the company generated robust free cash flow of $16.1 billion in the quarter and $63 billion over the last 12 months. As a result, it ended the period with $116 billion in cash and marketable securities.

The company’s cash war chest and copious free cash flow give it the financial firepower to continue growing shareholder value. It can use the money to repurchase its cheap shares, make capital investments, and complete acquisitions. It recently closed its $5.4 billion purchase of Mandiant to bolster its cybersecurity offerings.

The company has a long history of making acquisitions that help drive growth. With the tech industry experiencing a slowdown over the past year — taking company valuations lower — Alphabet has the financial firepower to go on the offensive and capitalize on this opportunity.

Fetching an enormous opportunity
I’ve been steadily adding to my position in Datadog since initiating it in early 2021. A big driver is its steadily falling share price despite a blistering growth rate.

Datadog’s annual revenue has expanded at a 74% compound annual rate since 2017. Sales were up 61% year over year in the third quarter to $436.5 million. While the company is losing money on a generally accepted accounting principles (GAAP) basis, it’s starting to produce lots of free cash flow. Free cash totaled $67.1 million in the third quarter, growing its cash position to $1.8 billion.

The company offers clients an all-in-one cloud observability, monitoring, and security platform that helps reduce complexity. Datadog sees a massive opportunity for its core observability capabilities. It foresees the total addressable market for that solution growing from $41 billion last year to $62 billion by 2026.

Datadog can continue growing briskly as it wins new customers and expands existing relationships. A growing number of clients are subscribing to additional products, helping drive strong retention and organic growth rates. The company’s dollar-based net retention rate has been above 130%, implying it’s retaining customers and growing those relationships. While 80% of its customers already use at least two products, only 40% use four or more (up from 20% two years ago), and 16% use six or more (up from 0% two years ago). Because of that, it has a tremendous upselling opportunity within its existing customer base.

Grabbing more growth while it’s on sale
Growth stocks have sold off over the past year. That’s allowing me to steadily scoop up additional shares of some of my favorites, like Alphabet and Datadog. While their stock prices could continue to fall in the near term (allowing me to buy even more shares), their robust revenue and earnings growth should drive their stocks much higher over the long term.

— Matthew DiLallo

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Source: The Motley Fool