DigitalOcean Stock Is Crashing, but AI Demand Is Red Hot

Shares of cloud-computing company DigitalOcean (NYSE: DOCN) are down 17% in 2025 even though business is booming more than expected and management expects record-high revenue for the year. This juxtaposition creates an interesting situation for investors.

Consider that on May 6, DigitalOcean reported financial results for the first quarter of 2025. The company reported quarterly revenue of $211 million, which was up 14% year over year. For perspective, Wall Street was only expecting revenue of about $209 million.

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Moreover, DigitalOcean's management believes it will generate revenue of up to $890 million in 2025. This would represent almost 14% year-over-year revenue growth. Not only is that record-high revenue potential, it would also be better than its 13% growth rate in 2024.

In short, DigitalOcean's growth could be accelerating more than expected, and yet shares are down in 2025. Zooming out further, it's still down nearly 80% from highs in 2021, which could exasperate some investors.

As it turns out, artificial intelligence (AI) now appears to be boosting DigitalOcean's growth rate, a trend that could continue for multiple years. That's why this is a good stock for investors to take another look at today.

How AI is making a big splash in this ocean

Cloud computing is advantageous for many enterprises. Rather than building a technology stack from scratch, the best computing power and applications is immediately available from a provider such as DigitalOcean. For its part, the company tends to focus on smaller businesses -- for perspective, it has around 400,000 customers who spend less than $50 a month.

This focus on smaller customers has perhaps allowed DigitalOcean to grow without much resistance from much larger public-cloud players. But growth hasn't been smooth for the company. In recent years, existing customers started spending less, on average, on the platform.

This is measured with a metric called the net dollar retention rate (NDR). Any number above 100% means customers spent more on average compared to the prior year, and any number below 100% means customers spent less. In Q1, DigitalOcean's NDR was 100% -- not spectacular, but it had been below 100% for six straight quarters, a devastating trend for any software business.

DigitalOcean's budding AI capabilities have clearly served as a catalyst to get its customers spending money again. Management said that its Q1 annual recurring revenue for AI was growing at more than 160% year over year, and, "demand is outpacing the supply." That's a good thing to hear.

The downside is that providing AI infrastructure is expensive, and DigitalOcean's capital expenditures are consequently growing much faster than overall revenue.

DOCN Revenue (TTM) data by YCharts

Still, AI is expected to be a trend for years to come, putting DigitalOcean on the right side of things. Moreover, certain expenses are up, but the company is still profitable, with over $70 million in trailing-12-month free cash flow. And spending was weighted toward Q1, which means its profits should improve as 2025 marches on.

In other words, DigitalOcean is growing, investing in future growth, and maintaining profitability. That's a good combination. And it's reason for long-term optimism from investors.

Is DigitalOcean stock a good bargain?

Valuation is a nuanced subject and can't be handled succinctly. At the risk of oversimplification, many things can influence a price-to-sales (P/S) ratio valuation. But generally speaking, when the growth rate increases and the gross margin improves, usually the stock deserves a higher P/S valuation.

As the chart shows, the opposite has happened for DigitalOcean stock. Since new management showed up at the start of 2024, the company's growth has accelerated and its margin has improved -- both are above average right now. Nevertheless, its P/S ratio has dropped to just 3, which is a below-average valuation.

DOCN Operating Revenue (Quarterly YoY Growth) data by YCharts

In other words, it would appear that investors aren't giving DigitalOcean enough credit for what's happening with the business. Indeed, this stock might actually be a bargain today, assuming it continues to grow like it is now while improving profits.

In closing, I wouldn't necessarily call DigitalOcean stock my highest-conviction idea today. Being a small player in a big market has its challenges. Building AI infrastructure could become increasingly costly. And while its growth has improved, I'd still like to see it further improve from here.

That said, DigitalOcean's business is showing signs of life, and the stock's valuation doesn't appear to account for this. Therefore, DigitalOcean stock could be a rewarding investment today if its AI strategy continues to pay off.

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Jon Quast has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends DigitalOcean. The Motley Fool has a disclosure policy.