One of the most anticipated earnings reports for tech companies was just released by the secretive data analytics and artificial intelligence (AI) specialist Palantir Technologies (PLTR -0.93%). Palantir is primarily known for its close ties to the U.S. military and its Western allies as well as being a core pillar of Ark Invest Chief Executive Officer Cathie Wood's portfolio.
Since going public in 2020, Palantir has been no stranger to the headlines. Some investors view Palantir as a glorified consulting operation and have even urged shorting the stock. Meanwhile, the company has seemed to garner a loyal following within the retail investor community -- likely thanks in part to Palantir's eccentric CEO, Alex Karp.
The company's third-quarter earnings report was nothing short of extraordinary. The company is making major strides in AI and is giving big tech stalwarts such as Microsoft, Alphabet, and Amazon a real run for their money. After posting yet another quarter of growing profitability, Palantir is now officially eligible for inclusion into the S&P 500. Let's explore why this is such a big deal, how the company became eligible, and if the stock is worth buying right now.
How does a company become included in the S&P 500?
To be included in the S&P 500, a company must meet a series of criteria. While the exact requirements around some of the financial parameters can fluctuate, the general items largely remain the same.
To be eligible for the S&P 500, a company must meet minimum requirements around market cap, traded share volume, time as a public company, and profitability. For the sake of this article, my focus will be on profitability.
What has Palantir done to reach eligibility?
To be included in the S&P 500, a company's earnings for the last four quarters must sum to a net positive. Of note, the most recent quarter of a company's earnings is included in this calculation. The chart below illustrates Palantir's net income (loss) for the last year on a generally accepted accounting principles (GAAP) basis.
Image source: Q3 2023 shareholder letter.
Investors can see that during the last 12 months, Palantir has generated a total of $148 million in net income. When speaking about these results in the company's recent shareholder letter, Karp stated, "The speed with which our company has shifted from losses to profits is a reflection of the power and sophistication of the software platforms that we have built and refined for years." The chart above makes it pretty clear that since Q3 2022, Palantir has transformed its operation considerably, underscored by rising profit. But how exactly was Palantir able to do this?
Palantir has spent the last several months touting advancements it's making in generative AI. Namely, the company released a new product earlier this year called Artificial Intelligence Platform (AIP) and claims to have experienced unprecedented demand since its launch. The one small issue with this is that Palantir's top line is not necessarily backing up management's claims. For example, the company increased revenue 17% for the latest quarter. While this is a sequential increase from the second quarter, which grew 13% year over year, it doesn't exactly align with some investor expectations.
While the revenue growth might appear mundane for some, investors should always take a thorough look at the entire income statement. Through the first nine months of the year, Palantir has kept operating expenses essentially unchanged. When you take that into consideration, Palantir's revenue growth begins to look a little more impressive. Essentially, the company has been able to generate double-digit sales growth during a tough macroeconomic period, and in the face of rising competition with deeper pockets, without using more resources.
Another important element is Palantir's lead generation strategy. To market AIP to the masses, Palantir is hosting immersive bootcamps where users can test Palantir's products and figure out use cases. I think the market is heavily discounting the potential of these bootcamps. In theory, Palantir is now able to cross-sell multiple products during the same sales cycle. This should allow Palantir to expand across its client base and increase its revenue per customer more quickly. While the obvious benefit of this is an accelerating top line, keep in mind that Palantir will also not need to allocate as much spending to acquire and retain new customers. This combination should lead to further profit boosts and robust cash-flow generation.
Image source: Getty Images.
S&P 500 or not, keep your eyes on cash flow
Right now it is all speculation whether Palantir will be included in the S&P 500. Either way, there are a lot of reasons investors should be bullish on the stock.
Image source: Q3 2023 investor presentation.
Palantir's financial profile is moving in the right direction on all fronts, and the company has the financial resources to double down on its AI vision. For the trailing-12-month period ended Sept. 30, Palantir generated $500 million in adjusted free cash flow. This is strengthening Palantir's balance sheet, which currently holds more than $3 billion of cash and equivalents.
The slide above from Palantir's Q3 investor presentation shows the trend in operating income over the past year. Investors can see that even with revenue only growing by mid-teen percentages, operating income has increased significantly throughout the year thanks to disciplined cost management.
To me, now is a fantastic time to scoop up shares in Palantir as the company continues to showcase how and why it's emerging as a leader in AI.
