Data analytics company Palantir Technologies (PLTR 6.38%) has been one of the most interesting stocks on Wall Street since it went public due to its mysterious nature, ties to the U.S government, and eccentric CEO Alex Karp.
Stock-based compensation is common practice for technology companies like Palantir, and there's often a surge of it when these companies first go public. Palantir has given employees more than $700 million in stock over the past year alone.
It's essential to understand the implications of stock-based compensation and how they can impact the financials of companies like Palantir. Here is what you need to know.
Why is Palantir giving out so much stock?
Palantir builds custom software solutions on its Gotham and Foundry platforms. These solutions help government and commercial customers integrate and analyze data, helping make the best decisions possible, sometimes in the heat of the moment.
Palantir's software requires very skilled employees to build and maintain these solutions for its customers, so human talent is arguably the most crucial resource. Companies fiercely compete for high-end talent, so Palantir must compensate its people well or risk losing them to other companies.
Stock-based compensation is a non-cash expense; the chart below shows how Palantir generates free cash flow, but the bottom-line profits (net income) are still negative due to the sizable stock-based compensation awards.
Rapidly growing companies want to invest all the cash profits they generate back into the business to further growth. Rather than pay their people high cash salaries, they sometimes give them stock in the company. It not only compensates them for their work, but it gives them a share in the company's performance; if the company thrives, they make more money via a higher price on their shares.
What excessive compensation does to a stock
Companies typically speak to their performance from the perspective of the business as a whole instead of on a per-share basis. Shareholders don't own the whole company, only as much as their shares represent, so they need to be vigilant in knowing how stock-based compensation can impact their investment.
Note that when companies create more shares, it dilutes existing shareholders by making each share worth a smaller piece of the company. Most think of this when a company issues shares to raise money, but stock-based compensation has the same effect.
The chart below shows how Palantir's total revenue has grown 82% since the company went public. Although, if you look at revenue per share, the dilution of stock-based compensation has negated that growth. Investors aren't getting any more revenue per share than when Palantir went public, despite total revenue increasing!
It's easy to look at Palantir's falling stock price and assume that it's a bargain because the company keeps growing. However, you need to be aware of how sizable stock-based compensation awards could make it a better business than it is a stock.
Should investors worry?
Before throwing your investment thesis away, keep in mind that stock-based compensation is typically the largest when a company goes public. Executives might get big payouts for bringing a business to the public markets.
Investors can see how stock-based compensation per quarter is steadily trending lower. It's vital that this continues, and is something investors will want to follow closely moving forward.
Palantir could play a significant role in how the government and public companies work with data over the years to come. However, the business will need to keep growing so that stock-based compensation becomes a minor part of the conversation around the company.