AI may dominate the headlines, but behind AI products is infrastructure that needs to be monitored, optimized, and cost-managed. That is why observability platforms matter more than ever. As AI adoption scales, observability is no longer just a backend tool but a financial and operational necessity.
What Is Observability and Why It Matters
Observability is how engineering and operations teams see what is happening inside complex cloud systems so that they can fix issues, improve performance, and reduce costs. Think of it as the dashboard of your cloud infrastructure – if something breaks or slows down, observability tools help you find it and fix it. Observability tools allow enterprises to scale their deployments with confidence and discipline.
Now, for AI workloads, observability is even more critical for two reasons.
1. AI workloads are resource-intensive and expensive: It is critical to track resource usage at a granular level to avoid waste from idle or overprovisioned compute infrastructure.
2. Ensuring performance and reliability: Observability platforms can identify if a model’s performance deteriorates – for example, latency spikes or failed API calls, allowing teams to resolve issues before they impact business outcomes. Since AI models rely heavily on timely, high-quality data, Observability systems can ensure that data pipelines are delivering accurate and complete inputs for model inference.
Now that we have reviewed the growing need for observability platforms, especially with AI adoption growth, let’s evaluate the market opportunity in this segment.
Scope of this analysis
To keep this analysis focused, I prioritize Leaders from the July 2025 published Gartner (NYSE:) Magic Quadrant for Observability and further limit the scope to pure-play observability vendors those that derive the majority of their revenue from observability offerings. This excludes conglomerates like IBM (NYSE:) and Cisco (NASDAQ:) (Splunk (NASDAQ:)) which have broader portfolios.
The three stocks I evaluate are:
- Datadog Inc (NASDAQ:)
- Dynatrace (NYSE:)
- Elastic NV (NYSE:)
Datadog
Per its most recent 10-Q filing, Datadog is the observability and security platform for cloud applications. Its SaaS platform integrates and automates infrastructure monitoring, application performance monitoring, log management, user experience monitoring, cloud security, and many other capabilities to provide unified, real-time observability and security for their customers’ entire technology stack.
Datadog is particularly known for its developer-friendly platform, ease of use, and rapid expansion into new capabilities across the observability stack.
As of the most recent quarter, it delivered 25% YoY revenue growth, ~79% gross margins, and a strong Rule of 40 score of 57%. Management emphasized accelerating demand for multi-product observability suites and increased enterprise cloud spend optimization. CEO Olivier Pomel noted continued strength among large customers with over 3,770 generating $100K+ ARR.
However, with a P/E of over 300 and a PEG of 6.89, it is priced at a premium, requiring flawless execution to achieve sustained, high earnings growth.
Dynatrace (DT)
Per its most recent 10-Q filing, Dynatrace offers the only end-to-end unified platform that combines broad and deep observability and continuous runtime application security with advanced Davis® hypermodal AI to provide answers and intelligent automation from data at an enormous scale.
Its comprehensive solutions help IT, development, security, and business operations teams at global organizations modernize and automate cloud operations, deliver software faster and more securely, and provide significantly improved digital experiences. Dynatrace is highly regarded for its deep automation, AI-powered root cause analysis (Davis® AI), and strong focus on large enterprise customers
As of the most recent quarter, it delivered ~81% gross margins, a Rule of 40 score of 44% and trades at a much more reasonable P/E of 34 with a compelling PEG ratio of 0.32. For investors seeking growth with discipline, Dynatrace presents the most balanced opportunity.
Elastic NV (ESTC)
Per their most recent 10-Q, Elastic, the Search AI Company, enables its customers to find the answers they need in real time, using all of their data, at scale. Its platform combines the power of search with AI to help companies solve real-time business problems, unlock potential value, and achieve better outcomes.
Elastic is particularly strong in log management and search, often appealing to teams looking for open-source flexibility within a managed service offering.
As of the most recent quarter, it delivered ~75% gross margins and 16% revenue growth but remains unprofitable. Since it is not yet profitable, the PEG ratio is not meaningful. However, it has a low valuation (P/S ~6.4) and could be a consideration for value investors who are betting on a turnaround.
6-month Stock Performance
Over the past six months, Datadog is up 6% while Dynatrace (DT) is down -5%. However, what is key to note is that both stocks have rallied since their last earnings report: DDOG is up an impressive 43% since May 6th, while DT has climbed 2% since May 14th. This divergence underscores investor optimism about Datadog’s AI-related growth strategy and suggests Dynatrace is due for a re-rating, especially given its low multiples.
Recommendation
As enterprises focus on accelerating their AI adoption, observability platforms are going to be the key next leg of the story. For investors:
- Dynatrace offers the best risk-adjusted return with strong growth, positive cash flow, and attractive valuation. They are set to announce FY2026 Q1 earnings next week on August 6th. Now is a great time to scoop this gem ahead of earnings.
- Datadog remains a premium play for growth-focused portfolios. They are expected to announce their FY2026 Q2 earnings next week on August 7th.
- Elastic may appeal to patient investors who believe in open-source observability.
