Datadog Beat on Revenue, Beat on Earnings, and Raised Its Outlook. The Stock Fell 19%.

Shares of Datadog (NASDAQ: DDOG) sank about 19% Thursday after the software company reported its second-quarter results. The reaction might seem odd.

Revenue grew 36% year over year, landing about $40 million above the high end of the range management forecast in May. Adjusted earnings came in ahead of the company's own guidance, too. And management raised its full-year outlook for both revenue and earnings.

But the market wasn't grading the quarter. It was grading what comes next. And tucked inside the raised outlook is a number implying Datadog's growth could slow meaningfully from here.

Image source: The Motley Fool.

A quarter with little to complain about

Datadog sells observability software (the tools companies use to monitor their applications, infrastructure, and security in one place). Demand for those tools has been booming as businesses roll out artificial intelligence (AI) applications they need to watch closely.

Datadog's second-quarter revenue rose 36% year over year to $1.12 billion. That's faster than the 32% pace it managed in the first quarter, and faster still than the 28% posted as recently as the third quarter of 2025. Customers spending $100,000 or more annually grew about 23% year over year, to about 4,720 from about 3,850. Non-GAAP (adjusted) operating income was $257 million, a 23% margin, up from 22% in the prior quarter. Free cash flow was $279 million, about a quarter of revenue.

The report also cleared the bar management itself set. In May, the company's forecast called for second-quarter revenue of $1.07 billion to $1.08 billion, and adjusted earnings of 57 to 59 cents per share. It delivered $1.12 billion and 65 cents.

Of course, not everything was perfect. On a GAAP basis, operating income was roughly break-even at $5 million, so the impressive profit figures are adjusted ones.

Still, Datadog finished the quarter holding $5.0 billion of cash and investments, and it produced $316 million in operating cash flow during the period.

Management responded by raising its outlook: It now expects full-year revenue of $4.45 billion to $4.47 billion, up from the $4.30 billion to $4.34 billion it forecast in May. The full-year adjusted earnings forecast moved up as well -- $2.50 to $2.54 per share now, against $2.36 to $2.44 before. And guidance calls for adjusted operating income of $1.01 billion to $1.03 billion, which would keep the margin near 23%.

The number investors appear to have seized on

So why the sell-off? I think the answer sits in the third-quarter guidance.

The new outlook puts third-quarter revenue at $1.135 billion to $1.145 billion, along with adjusted earnings of 63 to 65 cents per share. Datadog generated $886 million of revenue in the third quarter of 2025, meaning the midpoint of the new range implies year-over-year growth of about 29% -- a big step down from the 36% pace the company just delivered.

In other words, after adding more than $110 million in sequential revenue last quarter, Datadog is forecasting only about $20 million more in the current one.

Sure, the company just cleared its own second-quarter revenue bar by about $40 million, and it may simply be guiding conservatively again. But even a repeat of that outperformance would put third-quarter growth at about 34% -- below the pace it just posted.

That step-down matters because of the price. Even after Thursday's drop, the stock was still trading near $229 as of this writing, and it sells for about 91 times the adjusted earnings management expects for the full year. That's a price that only works if growth stays exceptional.

After all, heading into the report, the stock had nearly tripled from its 52-week low of $98.01 and closed Wednesday within about 4% of its 52-week high. Expectations were enormous.

Ultimately, I think the sell-off says more about the stock's starting point than about the business. Datadog is executing about as well as a software company can. Even the growth rate the new guidance implies -- about 29% -- would be fast for a business on pace for more than $4 billion in annual revenue.

But slowing growth is a hard sell at a valuation above 90 times expected earnings.

Daniel Sparks and his clients do not have positions in any of the stocks mentioned. The Motley Fool has positions in and recommends Datadog. The Motley Fool has a disclosure policy.