Is Palantir's Stock Getting Too Hot to Handle?

Palantir (PLTR -0.23%), a data-mining firm that generates most of its revenue from government contracts, went public via a direct listing in late September. The New York Stock Exchange set a reference price of $7.25 per share for the stock, and it closed at $9.50 on its first trading day.

However, Palantir's stock subsequently traded sideways as insiders sold tens of millions of shares. Those sales weren't surprising, since direct listings let private shareholders sell their shares to public investors. That's different from a traditional IPO, in which new shares are issued and sold.

But in early November, Palantir's stock started climbing ahead of the release of its third-quarter report on Nov. 12. After Palantir posted those numbers, the stock price surged to the low $30s by the end of November before pulling back to the low $20s currently.

Palantir's growth rates are impressive, but is the stock getting too hot to handle after tripling (at least temporarily) in just over two months? Let's review its growth rates and valuations to decide.

Image source: Getty Images.

How fast is Palantir growing?

Palantir's revenue rose 25% to $743 million for the full year in 2019. But in the first nine months of 2020, its revenue rose 50% year over year to $771 million.

During that period, 55% of its revenue came from Gotham, its platform for government agencies. The remaining 45% came from Foundry, a version for large companies that carves its features up into smaller modules. Both platforms operate by gathering and organizing data on individuals through disparate sources.

Image source: Getty Images.

During the first nine months, Palantir's revenue from Gotham rose 73% year over year. That growth was mainly attributed to several recent deals, including a $91 million artificial intelligence (AI) contract with the U.S. Army and a $36 million contract with the U.S. National Institutes of Health for cancer and coronavirus research. It also noted its work with federal healthcare organizations had "accelerated" throughout the pandemic.

Palantir's revenue from Foundry rose 30% year over year. It secured a $300 million renewal from a top aerospace customer and noted its software was increasingly used to optimize operations across the "automotive, manufacturing, aviation, healthcare, and banking sectors" during the pandemic. Foundry's robust growth was encouraging since the enterprise market arguably has more long-term growth potential than its walled garden of government contracts.

It isn't profitable, but its margins are improving

Palantir's net loss narrowed slightly from $580 million in 2018 to $579.6 million in 2019. In the first nine months of 2020, its net loss widened from $420.3 million to a whopping $1.02 billion -- mainly due to stock-based compensation expenses and its direct listing costs.

However, Palantir's adjusted gross margin, which excludes those expenses, actually expanded year over year from 71% to 79% during the first nine months. On the same basis, it posted a positive operating margin of 25% in the third quarter -- up from a negative operating margin of 48% a year ago.

This means that Palantir's net losses could gradually narrow after it moves past the initial costs of its public debut, but it probably won't turn profitable on a GAAP basis anytime soon.

Is Palantir's stock overvalued?

Palantir expects its revenue to rise by 44% to $1.07 billion for the full year. It hasn't offered any guidance beyond that, but analysts expect its revenue to rise 32% to $1.41 billion next year.

Based on those forecasts and a stock price of $27, Palantir's stock trades at 48 times this year's sales and 36 times next year's sales. Here's how that price-to-sales ratio compares to two other silo-busting companies with similar revenue growth rates, JFrog (FROG 1.69%) and Datadog (DDOG 0.50%):

Source: Yahoo Finance, Dec. 1.

Palantir's valuation looks comparable to JFrog's and only a bit pricier than Datadog's. Therefore, Palantir was merely catching up to those hot IPOs over the past two months after its initial wave of insider selling. JFrog and Datadog both went public via traditional IPOs and skyrocketed on the first day.

I recently noted JFrog's stock was getting too hot to handle at these levels, however, and the same should now be said about Palantir. Paying over 30 times sales for an unprofitable company with decelerating revenue growth is risky in this frothy market, especially when some companies with comparable growth rates are trading at lower valuations.

For example, analysts expect Alibaba's (BABA 2.92%) revenue and earnings to rise 31% and 21%, respectively, next year. But the Chinese giant's stock still trades at 29 times forward earnings and five times next year's sales -- which makes it much cheaper than Palantir.

I'm not selling, but I'm not buying right now either

I bought all my shares of Palantir below $10 back in September, and I didn't add any more shares over the past two months. I won't sell my shares anytime soon, since I still admire Palantir's long-term growth potential, but I also won't add more shares right now -- there's already too much optimism baked into the stock.