Artificial intelligence (AI) stocks have captivated investor attention this year like nothing else. The launch of ChatGPT a year ago opened the market's eyes to the potential of new generative AI technologies, and investors have raced to find potential winners.
Palantir Technologies (PLTR +0.30%) has been one of the top AI stock picks, due to its prowess in artificial intelligence-driven data analytics. The stock has more than doubled this year. Palantir was founded in 2003, developing software for counterterrorism investigations for the intelligence community. It was able to connect the dots from massive, disparate datasets to deliver insights and disrupt terrorist plots.
In the age of generative AI, Palantir's technology is in demand by governments as well as big business. The company only has a few hundred customers but deals with complex projects and large contracts, averaging in the several-million-dollar range annually.
The company is generating solid growth. Revenue is up 17% to $558 million in the third quarter, and adjusted operating income doubled from the quarter a year ago to $163.3 million, giving the company a 29% adjusted operating margin.
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Unlike many AI stocks, Palantir is also profitable based on a generally acceptable accounting principles (GAAP), as total operating costs have fallen from a year ago. In the third quarter, it reported GAAP operating income of $40 million, up from a loss of $62.2 million. With the help of interest income, GAAP net income reached $71.5 million in the quarter, marking its fourth straight quarter with positive GAAP net income.
That achievement prompted CEO Alex Karp to declare, "Our company is now eligible for inclusion in the S&P 500, a milestone that we have been working toward and knew was within reach."
Palantir's next stop: S&P 500?
In order to gain entry into the S&P 500, a company must be headquartered in the U.S. and have a GAAP profit over the last four quarters. In addition, a majority of shares outstanding must be available to the public to buy and sell, and the company must have a market capitalization of at least $14.5 billion, S&P Global's current threshold for large-cap stocks.
Indeed, Palantir now meets all those requirements, but to gain entry to the high-profile, broad-market index, it must replace another stock, and the criteria for removal and addition aren't fully clear. Palantir's market cap of $40 billion makes it more valuable than nearly 300 of the 500 stocks on the S&P 500, making a good argument for its inclusion in the index.
The S&P 500 changes members periodically. Generally, about 20 new stocks join the index in a year.
NASDAQ: PLTR
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What S&P 500 membership would mean for Palantir
Stocks typically get a bump of 5% or so when they're added to the S&P 500. That's primarily because index funds that track the broad-market index need to add the stock to their funds when it joins the S&P 500, but it also acts as a stamp of approval from the benchmark index.
Other high-profile stocks that have recently joined the S&P 500 are Uber, which gained as much as 6.2% on Dec. 4 when it was added to the S&P 500, and Airbnb, which jumped 7.2% on the news on Sept. 5.
For Palantir, gaining admission to the S&P 500 in 2024 could be one of many catalysts to drive the AI stock higher. Management has clearly demonstrated its ability to control costs and grow profits. If the company continues to do that, it will surely join the S&P 500, though that may not come next year.
The company's investors will also keep an eye on Palantir's new AI platform and its overall growth rate to see if it's fulfilling its promise of penetrating the massive market for AI-driven data analysis. The stock is expensive today, but if it can ramp up profitability and grow the top line, shares should move higher, especially if it gains S&P 500 admission.
