Palantir (NYSE:PLTR) is one of many new stocks making their trading debuts in 2020 that have performed well beating the performance of major stock indices. Should you avoid Palantir stock, buy it, or shortlist it and monitor its stock price and financial performance?
Palantir stock opened at $10 per share in its first day of trading on the last day of September 2020, with a direct listing on the New York Stock Exchange (NYSE) and not an IPO such as Airbnb (NASDAQ:ABNB) or DoorDash (NYSE:DASH). The pre-launch price of PLTR stock was $7.50 per share, and the stock made a 52-week high of $33.50. Not bad for stock trading for less than three months in 2020.
IPOs and direct listings have several risks and Palantir stock is no exception. And while there are two contradicting opinions on Palantir stock on InvestorPlace, one arguing keeping PLTR stock for the long run and one arguing Palantir stock will face key risks in the future, what is my financial analysis and opinion about Palantir stock?
I will base my investment thesis on three key catalysts, the valuation, the risks, and the financial performance of the stock.
Palantir’s Valuation
Most probably will argue in favor of buying Palantir stock, being in a strong uptrend. Buying a stock and ignoring its valuation or fundamentals is like gambling and is never a good idea for investing. If one key financial metric shows that Palantir stock is too overvalued, it is the stock’s price-to-sales ratio. This is in essence how much money investors are paying for each dollar of revenue generated by the company. The lower the price-to-sales ratio, the more attractive a stock is from a valuation perspective.
According to Morningstar, Palantir stock has revenue for the trailing 12 months of $1 billion and with a current market capitalization of about $51 billion, the price-to-sales ratio for Palantir stock is 51 times.
This financial metric is useful only when compared to the relevant metric of the peers and the industry average to argue whether a stock seems relatively overvalued.
As Palantir stock belongs to the software industry and the technology sector, data from CSIMarket shows the following interesting key points:
- Software & Programming Industry: Price to Sales (TTM) ratio for the third quarter of 2020 is 9.36. https://csimarket.com/Industry/industry_valuation_ttm.php?ps&ind=1011
- Technology Sector: Price to Sales (TTM) ratio for the third quarter of 2020 is 9.35.
For Palantir stock, the almost 5.5 times more than the price-to-sales ratios for the third quarter of 2020 for its industry and sector is not justified. And it is too excessive.
Palantir Stock Risks
Palantir relies too much on one major client for generating revenue, the U.S. government. The company stated that in its first earnings report since it went public “The U.S. government sector remains a primary area of focus for our business.”
I do not think that having too much dependence on a major client a very good or sustainable business model to generate revenue. This government business may be subject to lower future revenue. New priorities in public spending and a different budget from the new-elect U.S. government may not be positive news for Palantir.
And competition both in the U.S. and on an international level in markets such as in Asia, Europe will be too intense as the company has plans for its international expansion. Which makes me wonder, what is the competitive advantage for Palantir? It could well be the know-how, but does the stock has made any progress in its financial performance?
Palantir Stock Financial Performance
The company in its first public earnings report about a month ago reported the following:
“$289.4 million in revenue in the third quarter, up 52% year-over-year
Full-year 2020 revenue guidance raised to a range of $1.070 billion to $1.072 billion, up 44% year-over-year
New contracts in third-quarter include U.S. Army ($91 million), National Institutes of Health ($36 million), and $300 million renewal with aerospace customer.”
The company also raised its full-year 2020 guidance. Are these reasons to buy the stock? This positive news is only one side of the most recent financial performance for the stock.
For a longer trend of the financial performance of the Palantir stock some important key points are:
- The company is unprofitable. And it has debt that did not in 2018. For a company that turns to debt financing without being profitable, this means extra pressure on the profitability.
- Gross margin declined from 72.2% in 2018 to 67.4% in 2019, and to 64.2% on a TTM basis.
- The operating margin is negative. It improved from -104.7% in 2018 to -77.6% in 2019, but deteriorated again to -116.5% on a TTM basis.
- Free cash flows are negative for 2018 and 2019. Still, the company for 2020 has on a TTM basis positive free cash flow reported of $47 million.
The Bottom Line
For a company with a current valuation of about $51 billion, the free cash flow of 2020 so far is too low to justify the valuation of the stock.
Taking into consideration the valuation, the high risks, and the financial performance of the Palantir stock, I argue that the stock is significantly overvalued. And at the current price level, buying the stock offers no margin of safety.
With only two fiscal years of full financial data, an argument in favor of buying Palantir stock seems unjustified as the revenue growth is solid, but fails to translate into profitability.
On the date of publication, Stavros Georgiadis, CFA did not have (either directly or indirectly) any positions in the securities mentioned in this article.