Since the launch of OpenAI's ChatGPT in November 2022, investor interest in artificial intelligence (AI) stocks increased by leaps and bounds.
Many companies are also racing to increase their AI-related capital expenditures in hopes of benefiting from this megatrend. In fact, according to Savita Subramani, head of U.S. equity and quantitative strategy at Bank of America Global Research, the number of AI mentions in the corporate earnings calls rose 64% year over year in the first quarter of 2023.
AI is deeply embedded in Palantir Technologies' (PLTR 0.51%) core business. Its stock price is up by nearly 127% so far this year, yet remains 55% below its all-time high in January 2021. So, is its bull rally reliable? To find out, let's analyze the bullish and bearish drivers for the company in greater detail.
The bull case
Palantir Technologies has long been well known for its superior AI and data analytics capabilities. Its cutting-edge software offerings (Palantir Gotham, Palantir Apollo, and Palantir Foundry) help government agencies and private organizations crunch huge mounds of data rapidly to derive actionable insights.
AI was a major part of its business model even before it became the hot new tech theme. In an IDC study Worldwide Artificial Intelligence Platforms Software Market Shares, 2021: AI is Being Used in More Unique Ways Than Ever, Palantir was ranked as the top AI software platform.
And it's not resting on its laurels. Palantir has now come up with a game-changing product. The company recently launched a large language model (LLM) called an artificial intelligence platform (AIP), which enables the company to deliver an interactive chatbot experience to its clients while helping them make informed decisions. The company is also investing in developing the foundational systems and software architecture required for clients to derive benefits from the LLM model. Thanks to these efforts, the company is already seeing unprecedented demand for its AIP offering.
While AIP is poised to be a major growth driver for Palantir, the company's existing business is showing robust signs of improvement. In the first quarter, revenues from government clients rose by 18% year over year to $525 million. The company is also on track to reduce its excessive dependence on the government sector. Palantir's commercial customer count was up by nearly 50% year over year to 280 at the end of the first quarter, despite it being a typically slow quarter. This was also faster than the 41% year-over-year growth rate seen in total customer count. Revenues from commercial customers accounted for nearly 45% of the company's first-quarter revenues. Beyond the expansion of its customer base, Palantir is also leveraging upsell opportunities with its new customers.
Palantir has been GAAP profitable for the past two quarters and expects to become GAAP profitable on an annual basis in 2023. The company is free-cash-flow positive and has a solid balance sheet with $2.3 billion in cash and equivalents and no debt, giving it access to funds for future growth.
Bear case
Despite the many positive things one can say about Palantir, some investors and analysts are concerned about its expensive valuation. The company trades at 14.9 times sales, which is dramatically higher than the software industry's median price-to-sales ratio of 2.4. In fact, Raymond James analysts downgraded the stock from a strong buy rating to outperform rating mainly due to its nearly 60% share price surge since it released its first-quarter results in early May 2023.
Since much of the near-term growth potential of the company is already priced into its stock, any unfavorable news event or earnings miss could have a dramatic negative impact on Palantir's share price.
Conclusion
At these elevated price levels, Palantir is not a stock for the weak of stomach. However, the company boasts of improving financials, a robust balance sheet, and strong AI capabilities. Hence, risk-tolerant investors with investment durations of at least one year could consider opening a small position in this stock now.
