1 Green Flag and 1 Red Flag for Palantir

The amount of data generated through the digital world is immense. However, it is nearly impossible to make sense of what message it conveys without the help of a powerful software program. That's where IDC's 2021 top-ranked artificial intelligence (AI) software, Palantir (PLTR -1.55%), comes in.

Palantir's product started as a government-first technology but expanded into commercial businesses. Despite its overall growth, Palantir's stock has had an abysmal public life, with the stock down 26% since its IPO in late 2020. If you're looking for the stock to turn around, there were some positive signs in Palantir's third-quarter results. But if you're a bear on the company, there's something for you as well.

The red flag: Slowing revenue growth will make it harder to break even

The headline number for revenue growth wasn't great: 22% year-over-year (YOY) growth to $478 million. In a vacuum, you may think that isn't an alarming number, but it continues the revenue slowdown trend that began long before the economy was showing signs of trouble.

Source: Macrotrends.

This trend wouldn't be so troubling if Palantir were fully profitable. Instead, it lost $124 million in Q3. Now, this figure takes into account stock-based compensation, a non-cash expense. In Q3, Palantir handed out $140 million in stock to its employees, down from $185 million last year. The reason why this metric is essential is shareholder dilution.

Think of it this way: If a company is a whole pie and each share is a slice of the pie, the more slices the company issues, the smaller your slice gets. Now, the trick is to grow the pie size faster than a company increases the slices, so shareholders aren't affected as severely. But, in Palantir's case, the size of the pie has shrunk (the stock is down 60% year to date), yet Palantir's share count has risen about 5.6% over the past year.

Many companies, especially young and fast-growing software businesses, do this same practice, so it isn't unique. However, as revenue growth slows, it will become more difficult for the company to reach a fully profitable state, especially when stock-based compensation makes up nearly 30% of its quarterly revenue.

Fortunately for investors, Palantir is growing in another area that will help its case out down the road.

The green flag: Customer count is rapidly rising

Despite revenue only growing 22% YOY, Palantir's customer count grew 66% YOY in Q3. As mentioned above, Palantir used to be a government-focused software company but has now expanded into the commercial side. This makes non-government customers a key growth area for Palantir, and with its commercial customer count rising 98% YOY to 228, it's excelling at its goal.

The company also accelerated against the second quarter's quarter-over-quarter (QOQ) commercial customer growth (12.3% QOQ in Q3 and 10.3% in Q2), displaying no signs of slowing down, even in the near term.

New customers are the lifeblood of Palantir, as its goal is to get one segment of a business to utilize its software and then expand its use throughout the company.

For example, Swiss Re, a Swiss reinsurance company, utilized Palantir's software to have a nine-figure USD impact ($100 million or more); now, over a third of their company utilizes Palantir's software. In addition, Tyson Foods utilized Palantir in 20 projects to create $200 million in savings. With results like that, upper-level management will want to roll out the software wherever applicable to realize savings.

All it takes is one positive outcome, and customers will significantly expand their use of Palantir's products. With Palantir rapidly growing its customer base, it's giving itself the best shot at having long-term revenue growth, although it may not be realized for many years.

So while Palantir's revenue growth is slowing in the near term, its long-term customer growth is still high, indicating Palantir's growth will likely accelerate if these customers choose to expand their use.

With full-year revenue guidance of about $1.9 billion, Palantir trades at 7.6 times full-year sales. That valuation probably makes sense with the company in its unprofitable and slowing revenue growth state. However, this multiple could quickly expand if Palantir's revenue growth returns and losses narrow.

This could happen in a few years with Palantir's rising commercial customer count. If you've got a long enough time horizon and believe in the company, now might be the time to take a position in Palantir. However, I think there are much better buys in the market right now than Palantir.