One the most polarizing stocks on Wall Street is Palantir (PLTR 1.38%). The Denver-based company has developed a series of software platforms that specialize in big data analytics and artificial intelligence (AI). While this may be exciting to some investors, others may not be totally sold on Palantir's position in the AI market relative to its Big Tech peers such as Microsoft, Alphabet, and Amazon.
Moreover, shortly after its initial public offering in 2020, the company become a frequent talking point of Ark Invest CEO Cathie Wood. Many retail investors poured into the stock following Wood's bullish commentary, propelling it upward to stratospheric levels. Unsurprisingly, Palantir's status as a meme stock was short-lived and it cratered in spectacular fashion.
While the stock has enjoyed some new life in 2023, primarily driven by the euphoria surrounding AI, there are several reasons to believe it's just getting started. After an eye-popping third-quarter earnings report, Palantir looks poised to dominate in AI.
Let's explore some of the catalysts for Palantir and then take a hard look at its valuation relative to some peers. While bag holders may still be sour about the stock's performance from a couple of years ago, I'd say it's best to leave that sentiment in the past. Now looks like a terrific opportunity to scoop up shares in this generational AI player.
How the mighty have fallen
The chart above illustrates Palantir's current stock price relative to its all-time high. You can see that the current price of roughly $18 is over 50% below its highs in 2021. This disparity is even more pronounced when you consider Palantir's 52-week range. Over the last year, the stock has been as low as roughly $6 and as high as $20.
Given that Palantir currently trades closer to its 52-week high yet is significantly lower than its valuation from a couple of years ago really shows how much movement there has been in a relatively short time frame.
Many technology stocks have enjoyed market-beating returns so far in 2023 thanks in large part to bullish outlooks on AI. Let's take a closer look at Palantir's latest earnings report and assess if the recent momentum that has entered the stock is justified.
Image source: Getty Images.
Giving Big Tech a run for its money
Earlier this year, Microsoft turned heads by invested a whopping $10 billion in OpenAI, the start-up behind ChatGPT. Alphabet and Amazon countered this move by both investing in the OpenAI rival Anthropic. During the most recent earnings results, each of these Big Tech players demonstrated that these strategic investments are already paying dividends.
Palantir, for its part, also reported impressive results for Q3 -- and the company has yet to make a splashy outside investment like its cohort above. I've been impressed by Palantir's progress so far this year, and its latest earnings tape has me more excited than ever.
The table below illustrates some of Palantir's most important financial and operating metrics.
| Metric | Q3 2022 | Q4 2022 | Q1 2023 | Q2 2023 | Q3 2023 |
|---|---|---|---|---|---|
| Revenue | $478 | $509 | $525 | $533 | $558 |
| Revenue growth % | 22% | 18% | 18% | 13% | 17% |
| Net income | ($124) | $31 | $17 | $28 | $72 |
| Free cash flow | $37 | $76 | $189 | $96 | $141 |
Data source: Company investor presentations. Dollar amounts in millions.
There are a few things to call out here. Palantir is doing a respectable job increasing its top line during a stormy macroeconomic environment. The Federal Reserve is doing good work in combating inflation -- but the September rate of 3.7% remains much higher than the 2% long-term target of the Fed. As inflation lingers and interest rates remain higher than historical levels, businesses of all sizes have reined in expenses.
Investors can clearly see that Palantir is not immune to these dynamics -- as evidenced by the company's revenue growth rates. Nonetheless, even as revenue growth stalls a bit, the company has quickly turned into a massively profitable operation. During the third quarter, Palantir reported its fourth consecutive quarter of positive net income, making it eligible for inclusion in the S&P 500.
Furthermore, the company has consistently generated positive free cash flow, which it's been using to reinvest into new products and services to help drive future growth. Perhaps the best part of the financial profile above is that Palantir raised its revenue and income guidance yet again following such a smashing earnings report.
While the financial strength of Palantir's business is clear, the stock has enjoyed a run-up of almost 200% so far in 2023. Given how generous it's been to investors this year already, it's appropriate to believe the stock is due for a pullback. Let's dig into some valuation analysis to see if now is an ideal time to buy the stock.
Should you invest in Palantir stock?
PLTR Price to Free Cash Flow data by YCharts
The chart above shows the change in Palantir's price-to-free cash flow over the past year. You can see that the stock is trading 25% off its prior highs by this measure. This is actually pretty interesting because the financial table above illustrates that Palantir has been expanding its free cash flow for several quarters now. And yet, even as cash flow compounds for the business, the stock price has still experienced some choppiness underscored by some heavier periods of buying and selling.
I wouldn't wait to see if there is a big pullback in the stock. Although it's trading near its 52-week high, it is still far below all-time levels. Moreover, since the stock traded at depressed levels for most of 2022 and early 2023, the company has made considerable progress especially as it pertains to AI. I view Q3 earnings as merely a preview of what's to come, namely because of Palantir's creative lead generation approach that is already yielding new business.
While the stock isn't exactly cheap, the current trading activity is very much in line with other growth stocks. I'd be buying at these levels with the expectation that revenue continues to accelerate and the company maintains a healthy cash-flow profile. Should Palantir demonstrate its ability to continue doing these things, it's only a matter of time before investors witness exponential top- and bottom-line growth, which could lead to a significant breakout in the stock. I think now is a great time to continue dollar-cost averaging into existing positions.
