Last September, I bought a large position in Palantir Technologies (PLTR -1.56%) at just under $10 per share after it went public through a direct listing. The market's interest in the data mining firm was muted at first, but its stock skyrocketed to $45 per share during the Reddit-fueled rally in late January.
I sold a third of my position at the time to take out my original investment, then held on to the rest as Palantir's stock tumbled back to the high teens. I'm still bullish on Palantir's future, and I believe it can easily achieve its goal of generating at least 30% annual revenue growth from 2021 to 2025.
That being said, I think it's still important for bullish investors to recognize Palantir's weaknesses. So today, I'll take a look at five red flags that might limit Palantir's near-term gains.
1. All that red ink
Palantir generated $1.09 billion in revenue in 2020, but it posted a whopping net loss of $1.17 billion.
In the first nine months of 2021, its revenue rose 44% year over year to $1.11 billion, while its net loss narrowed from $1.02 billion to $364 million. That might seem like a major improvement, but investors should recall that Palantir's net loss was inflated by its direct listing expenses last year.
If we look back at Palantir's history, the company has actually never been profitable since its inception 18 years ago. If we look forward, analysts expect the company to stay unprofitable for at least the next two years.
2. The rise of RAVEn
Palantir generates just over half of its revenue from government contracts. In its SEC filings, the company says its long-term goal is to make Gotham, its data mining platform, which serves dozens of government agencies, the "default operating system for data across the U.S. government."
But earlier this year, a leaked government document revealed that Immigration and Customs Enforcement (ICE) wanted to replace FALCON, the agency's customized version of Gotham, with a new in-house platform called RAVEn. ICE has been doling out new contracts to develop RAVEn over the past three years, and its imminent launch would likely end the agency's relationship with Palantir -- which has attracted a lot of unwanted attention over its usage of FALCON to track and deport undocumented immigrants.
If other government agencies follow ICE's lead and adopt RAVEn or develop their own in-house data mining platforms, Palantir's government-facing business -- which already reported decelerating revenue growth over the past two quarters -- could face an unprecedented slowdown.
3. Its ongoing stock dilution
Palantir's number of weighted-average shares rose 70% year over year at the end of 2020 following its direct listing. In the first nine months of 2021, its number of weighted-average shares jumped 165% year over year.
Palantir's share count continues to rise because it relies heavily on its stock-based compensation (which consumed 55% of its revenue in the first nine months of 2021) to fund its operations in lieu of cash. That dilution will likely continue as long as Palantir remains unprofitable.
4. Its high valuation
That dilution will also prevent Palantir's high valuations from cooling off. With a market cap of $36 billion, Palantir is still valued at 24 times this year's sales. The bulls will argue that Palantir's target of generating more than 30% annual sales growth justifies that higher price-to-sales ratio, but it's easy to find stocks with comparable growth rates at lower valuations.
For example, C3.ai (AI 1.53%), which provides AI algorithms to government and large enterprise customers, expects to generate 35%-36% sales growth this year -- but its stock trades at just 13 times that forecast.
5. Insiders are selling shares as its price declines
Over the past three months, Palantir's insiders sold 12.6 million shares while buying 11.8 million shares. That balance between sellers and buyers isn't too jarring, but Palantir's stock has also lost about a third of its value over the past three months, and is trading near its 52-week low.
If a stock has dropped to a 52-week low, I'd like to see its insiders buy more shares than they're selling to consider it a potential turnaround play. Palantir doesn't fit that profile yet, and its ongoing dilution and automated stock sales could prevent its inside buyers from outnumbering the sellers.
Why I'm staying bullish on Palantir
Palantir faces a lot of challenges, and it could remain out of favor as inflation-related fears drive investors away from higher-growth tech stocks.
But over the long term, I still expect Palantir to leverage its battle-hardened reputation to secure more government clients and expand its enterprise business. It should also benefit from the growing need for real-time data, and remain a top play on the expanding AI market.
Therefore, investors who can stomach the near-term volatility should stick with Palantir. Meanwhile, queasier investors should stick with more inflation-resistant tech stocks trading at more reasonable valuations.