Here’s what to know as earnings approach.
With its recent addition to the S&P 500, Palantir (PLTR 0.87%) is taking center stage. While the company isn’t new — it was founded by Peter Thiel, Stephen Cohen, and Alex Karp in 2003 — recent advancements in artificial intelligence (AI) have supercharged its abilities. The intelligence company is demonstrating that real-world applications of AI are driving real-world value.
That’s no small point. While Nvidia is raking in billions of dollars selling AI hardware to big tech giants like Amazon and Alphabet, anxiety has grown over whether the technology can justify its massive expense. Palantir is part of a batch of companies doing just that.
The company will report its Q3 earnings on Nov. 4. The release is highly anticipated as investors are keen to see its revenue growth continue apace. So, should you buy Palantir ahead of the market close on Nov. 4? Let’s consider a couple of critical factors first.
1. Palantir’s business is strong
The company’s revenue sources can be lumped into two distinct segments: government and commercial. The former is largely how the company made its name. For more than a decade, it has worked with agencies such as the FBI, Department of Homeland Security (DHS), National Security Agency (NSA), and Immigration and Customs Enforcement (ICE). This garnered the company some pretty negative press, something it still deals with today.
At the same time, these contracts have proved lucrative. The great thing about working with government intelligence agencies is that because the barriers are so high, you have a built-in moat to protect your business once you’ve cleared them. The company has expanded beyond the U.S., offering its services internationally to the U.K., Ukraine, Israel, and others. There is no shortage of potential customers at this point.
The company’s commercial segment is nearly as valuable — representing about 45% of its income last quarter — and growing rapidly largely because its customer base is swelling, especially in the U.S. The company grew its domestic customer list by a whopping 83% year over year last quarter, helping drive the 33% year-over-year revenue growth for the segment. And while the company is bringing in more cash, it’s also been cutting costs, meaning its net income has really taken off.
Those are the trends investors want to see. As far as the fundamentals are concerned, Palantir is in a great position.
2. Its gargantuan valuation will weigh on the stock price
Business fundamentals are important, but you’re not buying the stock in a vacuum. Valuation matters, too, especially when there is a lot of hype involved. By just about any metric, Palantir carries a very hefty premium. Its price-to-earnings ratio (P/E) is currently more than 240. For context, Nvidia carries a P/E of around 60, which is already considered very high. Alphabet’s is just 23.
OK, but Palantir is in high-growth mode, right? Doesn’t its future earnings justify its valuation? Maybe, but even if we look at metrics that take the future into account, Palantir’s valuation should still make you pause. Its forward P/E — its current price versus its expected future earnings — is north of 100. That’s still almost 3 times that of Nvidia’s and 5 times that of Alphabet’s. Its PEG ratio — a metric that takes a company’s rate of growth into account — is 2.2 — twice that of Nvidia and Alphabet.
You can certainly get lost in the weeds here looking at different valuation metrics; ultimately, they’re only guides. It’s clear, however, that Palantir’s stock is expensive; the market has priced in a whole lot of growth already. I’m not sure that it can keep up a pace of growth that will justify this. Eventually, even as it continues to grow earnings, the stock price won’t keep pace. I would proceed with caution here.
John Mackey, former CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. Johnny Rice has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Alphabet, Amazon, Nvidia, and Palantir Technologies. The Motley Fool has a disclosure policy.
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