Palantir Stock Pumped on Palpable AI Hype
Want to know a quick way to reduce the volatility in your portfolio? Stop looking at it so often. When you’re constantly talking about a stock day and night, it’s easy to fall into the trap of convincing yourself it’s “the next NVIDIA.” More importantly, you’ll lack the ability to distinguish hype from substance. That’s where many Palantir (PLTR) investors sit today as the company reaches a loftier valuation with every new press release that gets pushed out.
The value of any stock is simply the present value of future cash flows. Growth stocks promise strong revenue growth – and rich valuations – while value stocks revert to weaker valuations because growth has slowed and most of the value is returned to shareholders today in the form of buybacks and dividends. While Palantir is thinking about buying back shares with the $3.7 billion in cash they’re sitting on, they’re still very much considered a growth stock. So, let’s start by looking at how much they’ve been growing.
Palantir’s Revenue Growth
One of the biggest mistake newbie investors make is to become caught up in the stories being weaved by glorified salespeople who run companies. That’s their job. To sell the prospect of the company to investors. Our job is to look past the window dressing at the ground truth for disruptive tech companies – revenue growth – which is a proxy for market share being captured. It all comes down to how fast you’re growing revenues for whatever great solution you’re selling. Here’s a look at how fast Palantir is growing revenues alongside Wall Street software-as-a–service (SaaS) darling, Snowflake (SNOW).
We can see both companies have seen strong growth that’s tailing off (expectedly) as they scale, and valuations would be expected to adjust accordingly (more on this in a bit).
Another key growth metric investors need to monitor is net retention rate (NRR) which shows how eager existing customers are to spend more money on any given platform. In 2021, Palantir provided this metric across all four of their revenue segments (government, commercial, U.S. government, U.S. commercial). Then, they started providing it at an aggregate only, and finally swept it into the footnotes when the trend started looking like this.
Most SaaS companies are seeing NRR trending lower over the past several years as companies tighten their purse strings, but 120% is considered average, and Palantir’s existing customers are spending less than that over time. Is the weakness in commercial clients or government clients? We don’t know because the company stopped providing that information.
To summarize, Palantir’s revenue growth isn’t matching the excessive valuation it commands, and this behavior is prevalent among a broader set of AI stocks being hyped right now (some for good reason, others because they contain the letters “AI” in their company name). We’ll discuss this excessive AI hype in a coming video on our YouTube channel, but let’s continue with the topic du jour.
The Titan Contract
The immediate characterization of any press release as “great news” without putting things into context seems to be standard behavior these days as AI hype sweeps investors looking for “the next NVIDIA” which – as it turns out – is actually NVIDIA. Palantir’s guidance of 19% revenue growth for 2024 – compared to 17% realized in 2023 – should be expected when companies are investing in AI hand over foot.
Last quarter, Palantir saw nearly 40% of their revenues come from the U.S. government, a shadowy customer that doesn’t like their vendors to be blabbing about what they’re up to. It’s characteristic of defense companies to miss expectations and say, “Well, we can’t really talk about it,” while simultaneously shouting from the rooftops anytime there’s any sort of win. The reality is, Palantir’s recently lauded TITAN contract has been known about for a while.
Palantir Technologies announced today that it is one of two companies awarded a prime contract by the Army to build a prototype for the Tactical Intelligence Targeting Access Node (TITAN), the first Intelligence ground station enabled by Artificial Intelligence and Machine Learning (AI/ML).
Palantir: 2022
Palantir first started working on the TITAN prime contract back in 2022 and has now received follow-on work for that – $174 million over the next few years or roughly $22 million per quarter. That’s about a 10% uplift to the current U.S. government run rate, or not. It could have already been accounted for in the 19% guidance they gave for 2024 given it’s said to be their fourth-largest contract by run rate. While one Palantir executive touts that they’re “the first software prime,” perusing the 58,000 (known) contracts offered to the many prime contractors the government works with puts this claim into perspective. Regardless of how Palantir spins this win, the ground truth will always be revenue growth, ideally beyond the 19% growth they’ve guided towards for 2024.
What Palantir needs to do in 2024 is exceed expectations on the growth front to show that all the workshops they’ve been conducting, all the contracts they’re winning, are bringing in more dollars than expected (not customer count, dollars). Companies that say they ‘can’t handle all the demand for their product’ as Palantir has said should follow through on that. They also need to show continuing improvement on their net retention rate. Given that strong performance materializes, what would it take for us to like the stock?
Our Points of Contention
Let’s pretend that Palantir isn’t being hyped “to the moon” right now and that the stock trades at a reasonable valuation. Our last piece on Palantir’s Political Positioning talked about how bad an idea it is for any company to play politics. When over 40% of your bread and butter comes from the U.S. government, you’re always only four years away from a possible change of guard when priorities can shift and contracts can get canceled. In Palantir’s case, they’re eight months away from one of the most contentious elections in U.S. history.
Having a single customer account for over 40% of revenues is a huge risk for any company which is why the growth of commercial revenues is so important for Palantir. Below you can see commercial revenues expressed as a percentage of total revenues over time.
We’ll need that number to increase faster than several hundred basis points a year in order for U.S. government revenues to fall under 25%, an arbitrary number that’s certainly more palatable than the 40% it sits at today. When looking at the growth of revenues from 2022 to 2023 – $319 million – around 53% of that came from commercial customers and 28% came from new commercial customers.
Palantir needs to move further away from their strong dependency on a single customer before we would consider investing. When the third slide of an investor deck shows the CEO next to someone with a blurred-out face advertising which side they’ve taken in the global conflict du jour, it certainly hints at where their priorities are at the moment. It’s a turn-off for many customers, and that’s apparent to anyone familiar with Palantir’s foray into Europe.
Valuing Palantir Stock
Our recent piece on “Valuing NVIDIA” looked at how forward-looking price-to-earnings (P/E) ratios can be used to justify a stock’s lofty valuation. In the case of NVIDIA, taking the middle of analysts’ guidance for 2024 resulted in a forward P/E ratio in line with the Nasdaq benchmark (which could be overvalued to begin with). Here’s the math for today’s price alongside the same calculations for Palantir (data taken from Yahoo Finance):
- NVIDIA | $875 / 26.31 = 33
- Palantir | $26 / 0.35 = 74
- Nasdaq 100 Index = 33
So, Palantir would trade at $11.55 a share were it to be valued the same as NVIDIA or the Nasdaq, but regular readers know that we take a different approach to valuing disruptive tech companies. Our simple valuation ratio focuses on revenues as a proxy for market share captured, and we’ve plotted it over time for NVIDIA and Palantir.
As you can see, Palantir is priced as rich as NVIDIA without all the massive growth. Sure, that’s apples to oranges, but Palantir is overpriced when compared to nearly all the 180 stocks we calculate SVR for in our tech stock catalog. That includes Snowflake, one of the richest stocks in our catalog, at a current SVR of 17.
Our tech investing methodology prevents us from buying a stock that’s valued higher than three times our catalog average (six). A prudent approach investors can take is to look at the average SVR for Palantir (14) and NVIDIA (20) and then use that as a target for purchasing the stock once it inevitably reverts to the mean. This means that based on that latest quarterly results we wouldn’t buy Palantir at more than $15 or NVIDIA at more than $605 though we’re planning on buying neither. (NVIDIA remains our single largest position.)
Conclusion
Hanging on every word that Alex “We’ll Take It All” Karp says won’t help you make better investing decisions, nor will lauding every press release as the cure for cancer. The ground truth is always revenue growth, and the only company we see blowing expectations out of the water because of AI growth right now is NVIDIA. Perhaps this year Palantir will surprise investors by exceeding guidance while finally growing commercial revenues enough to meaningfully minimize their dependency on the U.S. government. We’ll check back with the company next year when the U.S. election dust settles to see if they’ve managed to exceed the lofty revenue growth expectations their current valuation implies.