Is it time for me to sell $DOCN? A perspective from a fan and hopefully soon to be ex-shareholder. This is not a bearish take, just a value-portfolio analysis perspective.

Summary

I like DOCN as a company, however I don’t think it’s a good stock to own for value-minded investors because I realized recently that it does not have clear/profitable competitive advantages and it’s own financials do not scream that its a value play compared to stocks that I own (GOOGL, PYPL, unfortunately NET) and the three alternatives (WBD, LULU, HOOD, WEN) that I would want to own. The following is my argument for why this is a stock better suited for mass diversification rather than for stock picking.

What I Used to Think about DOCN

I have been very partial towards DigitalOcean for the last few years even when it was trading in the $100s. Back then it seemed that many people (myself included since I was naive) did not understand the true value of these tech growth stocks. Only a few years later do we see the true valuations for some of these stocks.

I opened a position in March of this year due to being a DOCN customer myself. However in the last month, I started having doubts on whether DOCN is worth including in a individual stock portfolio of ~20 “undervalued” stocks. At one point, I was down 10%, and now I’m up 11% which is better than my benchmark $MORT which has returned 7% during this time. MORT is my benchmark because I was expecting interest rates to be cut and so I expected this ETF to appreciate in value once that happened while paying out* higher than the overnight federal funds rate / risk-free in the mean time.

Business-Competitive Analysis

The reason I’ve changed my mind about DOCN is not actually due to anything they’ve done incorrectly. It doesn’t matter that they are operating financially well, it doesn’t matter how nice their products are, it doesn’t matter that I personally prefer using DOCN to other platforms, it doesn’t matter that they care about small businesses, it doesn’t matter how cost effective they are¹. The reality is that DOCN competes in an environment with many competitors and substitutes. The barrier to entry is embarrassingly low as we see serverless competitors (substitutes to VPS) like Vercel and Netlify which don’t even buy hardware but people do end up spending more on them just because they choose to use JavaScript as a backend and didn’t know how much performance a $5/month VPS can provide. These serverless companies rent from AWS, offer their solutions on top, and sublet at a margin. Then there are the very cost effective market (look at serverhunter.com) so competing on price alone is how we get perfect competition. Lastly, there are the behemoths of the industry: AWS, Azure, GCS, Shopify (I believe every shopify storefront is hosted on Shopify), Alibaba Cloud, etc. which are more expensive, less intuitive (excluding Shopify, and I don’t know if its true for GCS or Baba Cloud), but offer some complex ready to use solutions (e.g. live streaming which Kick uses). Given that there are so many competitors that target basically every requirements a business may have (cost, solution, simplicity), I find it hard to use “competitive advantage” as justification to own DOCN unlike owning GOOGL. So that really leaves the question whether DOCN is currently undervalued on its own merits:

Financial Merit Compared to My Alternative Holds and Buys

P/E is over 60, Beta over 1.5, QoQ growth has been 2-4% last 3 quarters. FCF market cap yield is 3% compared to:

• 0.64% at Cloudflare which has a competitive advantage, however not actually worth owning for value investors
• 3% at Google (which is a mature & profitable company)
• 8.26% at PYPL (which has less competition in the payments space, is profitable, and has been around longer)
• Even LULU has 5% FCF yield and the short-term bull case for that is China.
• WBD with 33% FCF yield; this is the stock I will be buying with the proceeds
• HOOD: had a high FCF yield in March