Should Investors Be Worried After Palantir's Q1 Earnings?

Stock sectors such as cybersecurity and big-data analytics have been considered attractive areas to invest in over the past few years, which makes finding a company that operates at the intersection of these two growing markets a potential investing boon. At least, that's what many investors thought when a relatively new tech stock had its initial public offering in 2020.

But after one of the most highly anticipated public offerings of 2020, data analytics specialist Palantir Technologies' (PLTR -0.84%) stock is trading virtually where it started almost two years ago and it is down over 50% year to date. Many tech stocks over the past year have gotten caught up in the big drop as part of the broader market sell-off.

The question is, in times of high market volatility like now, how can investors identify the potentially promising stocks that will eventually bottom out and then recover relatively quickly on their way to new highs? Let's dig in and see if Palantir is one of these stocks and determine if it's a good buy right now at its current valuation.

Were Palantir's Q1 results really that bad?

Wall Street skeptics have criticized Palantir in the past for relying too heavily on large government contracts. Since its public debut, the company has focused a lot of effort on overcoming this criticism and developed products for the commercial sector as well in an effort to expand its addressable markets.

In fiscal 2022's first quarter, Palantir reported revenue of $446 million, an increase of 31% year over year. Revenue from commercial clients was up 54% year over year, adding 37 net new private-sector customers (now totaling 184) during the first quarter. 

First-quarter earnings underscore a trend the company has been working on for more than a year now. As you can see in the table below, Palantir's revenue growth by segment is definitely showing some changes, and shifting more toward the private sector. 

The revenue growth rate among commercial customers has nearly tripled over the past five quarters, while revenue growth in the government segment is leveling off.

Palantir's software is used by companies and governments in over 150 countries and in 36 industries. But its largest customer base is in the U.S., and that is also where its growth has accelerated significantly:

As it ramps up its commercial segment, the company has been aggressively investing in sales and marketing. During Q1, Palantir spent $160 million on sales and marketing, an increase of 18% year over year. Those rising costs, along with the slowing revenue growth in the government segment, have taken their toll on Palantir's near-term margin profile and cash flow generation. In Q1 2022, Palantir managed $35 million in cash flow from operations, which represented 8% of overall revenue. By comparison, cash flow from operations was $117 million, or 34% of revenue, in Q1 2021. 

In a market environment more focused on companies showing clear profit rather than the promise of future profit, inconsistent and lumpy financial results are scaring recession-fearing investors away.

Image source: Getty Images.

Emerging serviceable markets should help Palantir

In his shareholder letter, CEO Alex Karp stated, "Our business is a rare amalgam from an investing perspective that blends aspects of both value and growth." On the surface, this statement may appear a bit generalized or even be an enigma for those that do not follow Palantir closely. Since its IPO in 2020, Palantir has mainly showcased its flagship software platform, dubbed Foundry, which is used by both commercial customers and government entities. However, during the first quarter Palantir focused more heavily on some of its new developments, mainly its Apollo product. Similar to Foundry, Palantir hosted a webcast in late April during which it showed off some of the key functions of Apollo and its differentiating features. 

Over the last few quarters, Karp has addressed Palantir's focus on expanding its sales team both domestically and globally. Per its filings, Palantir provides great detail about its sales force and sales cycle. For nearly two decades, the company relied heavily on senior management's involvement during a sales engagement. While increasing expenses in the form of personnel, recruiting, and training will impact the company's near-term cash flow, the primary objectives of augmenting its sales force is to expand into new markets globally and identify use cases for new and existing customers. Should Palantir successfully execute on these objectives, customers may become stickier over time as they purchase additional software and Palantir becomes fully integrated into its clients' operations.  

Keep an eye on Palantir's valuation

While Palantir sells its software for hundreds of millions of dollars, it is becoming more clear that demand is not necessarily the company's primary challenge. Rather, fulfilling this demand in the form of a much larger, global sales operation is a key component to jump-starting more lucrative growth and less lumpy quarter-to-quarter financials. And so while Palantir appears like a growth stock due to its affiliation with other high-end enterprise software companies, Karp may be alluding that the company is focused on a long road ahead, and not necessarily one or two quarters into the future. For this reason, despite healthy revenue growth and a clean balance sheet, Palantir has traded more in line with value stocks. At its current share price, the most prudent thing for investors may be to slowly dollar-cost average into the stock and accumulate more shares while assessing future earnings.

Despite healthy revenue growth, Palantir stock continues to decline during these volatile market conditions. Keeping an eye on the fundamental growth aspects, key performance indicators, and where Palantir is reinvesting cash might provide a different perspective for long-term investors. It is important to remember that Palantir is very much in the early stages of growth investing. For this reason, the company's quarterly results could appear lumpy on occasion.

As of the time of this writing, Palantir trades at a price-to-sales (P/S) multiple of 9.8. In June 2021, it was trading at a P/S of 40.7. So the stock is clearly trading at a much more reasonable valuation. When you consider that management is guiding for annual revenue growth of at least 30% for the next several years, it should be considered a bargain.

Even with more-pronounced spending and less-robust revenue growth during the first quarter, Palantir still carries $2.3 billion of cash on its balance sheet and no outstanding debt obligations. Investors interested in the stock should try to learn more about how the company plans to deploy this capital to ensure continued growth and a path to consistent profitability.