Is Palantir's Stock Too Risky?

Palantir (PLTR -0.23%) has taken investors on a wild ride since its direct listing last September. The stock started trading at $10 per share and stayed nearly flat over the following month. However, Palantir stock started rallying in November and hit an all-time high of $45 a share in January. Its strong third-quarter report initially attracted more bulls, then positive buzz on Reddit's WallStreetBets forum catapulted the stock to fresh highs alongside GameStop and other "meme stocks."

Unfortunately, investors who chased Palantir were burned when the stock price plunged back to the low $20s. Should investors consider buying Palantir amid all those volatile swings, or is it still far too risky?

Image source: Getty Images.

What does Palantir do?

Palantir is a data mining company that collects and processes information with two main platforms, Gotham and Foundry.

Gotham mainly serves U.S. government agencies -- including the military, the CIA, the FBI, and ICE -- and plans to become the "default operating system for data across the U.S. government." Foundry offers lighter versions of these tools to commercial customers.

Palantir generated 56% of its revenue from government customers in 2020. The remaining 44% came from commercial customers.

How fast is the company growing?

Palantir's revenue rose 47% to $1.1 billion in 2020, with 77% growth in its government business and 22% growth in its commercial business.

Its government business benefited from new and expanded contracts with the FDA, the U.S. Army, and the U.S. Air Force. Its commercial business secured more big customers like Rio Tinto, PG&E, and BP.

Palantir's total number of customers that generated more than $10 million in annual revenue increased 50% during the year. Its average revenue per customer also increased 41% to $7.9 million.

Palantir's adjusted gross margin rose from 71% to 81%, while its adjusted operating margin improved from -45% to 17%. However, Its GAAP net loss -- which factors in its stock-based compensation, direct listing costs, and other one-time expenses -- still widened from $580 million to $1.2 billion.

Palantir expects its revenue to rise more than 30% in 2021. Analysts expect its revenue to rise 34%, but it should remain unprofitable for the foreseeable future.

What are the major risks?

Palantir faces three primary risks: competition, controversy, and valuations.

Palantir has locked U.S. government agencies into its platform, but it needs to expand its commercial business to continue growing. Yet many other companies -- including C3.ai (AI 0.09%), Alteryx (AYX), and salesforce.com (CRM -0.18%) -- all offer comparable data-crunching AI tools.

Palantir's relationship with the U.S. government showcases the strength of its tools, but it's also controversial. Its platform reportedly helped the Navy SEALs located Osama Bin Laden in 2011, but it has also been used to track and deport undocumented immigrants from the U.S. over the past several years.

Palantir's co-founder Peter Thiel has also been an outspoken supporter of the Trump administration. Those controversies might scare away some of Palantir's potential customers.

Palantir's stock remains pricey at 27 times this year's sales. That high price-to-sales ratio could limit its gains, especially if higher bond yields spark a rotation from growth to value stocks. Here's how its projected growth and P/S ratio stack up against those of its aforementioned peers:

Note: Figures are for the current fiscal year. Data source: Yahoo Finance, May 5, 2021.

Palantir might seem cheaper than C3.ai right now, but I'd argue that Salesforce -- which is also profitable on a GAAP basis -- is a more balanced and reasonably valued play on the AI and analytics market.

Is Palantir's stock too risky?

I bought Palantir's stock on its first trading day because its business seemed disruptive and it looked cheaper than many recent tech IPOs. However, I sold a third of my position after the stock price more than tripled in value earlier this year, since its valuations looked overheated.

I plan to hold on to my remaining shares of Palantir because I still believe it has tremendous growth potential in the government and enterprise markets. But the ride could be bumpy, so risk-averse investors should probably stick with more conservative growth stocks like Salesforce instead.