On Feb. 13, Palantir (PLTR -0.23%) released its fourth-quarter 2022 report showing that it beat analyst estimates for revenue and profits. The stock popped around 21% higher the next day, but gave back most of those gains over the next several weeks.
Considering that artificial intelligence (AI) stocks have been some of the hottest stocks in the market since the beginning of the year, should you buy Palantir's recent after-earnings dip?
Let's take a look.
Why it could be an excellent investment for a long-term investor
Palantir makes custom-made AI and machine learning (ML) applications for large government and commercial organizations. In 2022, Forrester Research named it a leader in AI and ML platforms, and International Data Corporation ranked it the No. 1 AI software platform for market share and revenue in 2021. With surging investor interest in AI, driven by the enormous public interest in the fastest-growing app in history, ChatGPT, it is little wonder that Palantir stock is up 30% year to date, compared to the S&P 500, up only a little over 3%.
More than just the public is interested in AI; businesses and government organizations adopting AI applications is a huge secular trend. Companies "needing to do more with less" use AI to increase employee productivity and help management make more informed decisions. Government agencies, the military, intelligence organizations, police, the Securities Exchange Commission, the Internal Revenue Service, the Department of the Treasury, and more need AI capabilities to create more efficient operations, make better decisions, reduce fraud, and reduce staffing.
Despite the economic slowdown, Palantir is translating interest in AI from government and commercial interests into revenue growth, as seen in the charts below.
Image source: Palantir.
Another thing to like about this company is that it achieved GAAP (generally accepted accounting principles) earnings-per-share profitability for the first time in its fourth-quarter 2022 results, which exceeded management's projection to achieve profitability in 2025.
Many people were skeptical about whether Palantir could achieve that 2025 profitability projection when management first made the forecast and thought it would take longer. Hence, the unexpected profitability shocked the market.
Image source: Palantir.
The best part is the company projects that it can maintain that profitability throughout the year. Suppose that is true. The stock would become much more attractive than many other technology investments lacking profitability.
Management attributed its fourth-quarter profit to solid revenue growth, fiscal discipline, a gain from the acquisition of the Palantir Japan joint venture, and progress in reducing stock-based compensation (SBC), something shareholders cheer as SBC dilutes the value of existing shares.
Dilution is a considerable risk for shareholders in an economic environment that reduces a company's growth rates. Should the company fail to grow fast enough to counteract the negative impact of dilution from SBC, the stock price could flatline or drop. Since we are in a slow-growth environment, it is great to see Palantir manage SBC expenses prudently, which not all tech companies do.
Palantir's fourth-quarter 2022 SBC expense decreased by $38 million from the fourth quarter of 2021, and was $213 million lower in 2022 than the previous year.
A few risks that can trip up the company
Palantir might still be on a post-earnings rally. But William Blair analyst Louie DiPalma threw a wrench into those plans by pointing out that six of the company's government contracts are up for renewal over the next year and a quarter, with three of them among the company's most significant. DiPalma also noted that competition from open-source solutions for those contracts could be fierce. As a result of DiPalma's bearish arguments, investors recently lost enthusiasm for investing in the stock.
There are also other issues with the company. For example, there is good reason to question the competence of management after it invested at least $400 million in special purpose acquisition companies (SPACs) across 2021 and 2022. Palantir expected to benefit from these investments based on the trade-off that investees would purchase its products.
However, some people viewed these investments as a reckless move by management, as it was apparent in 2021 that inflation was becoming a significant problem. And in 2022, the Federal Reserve started raising interest rates at its fastest pace in 40 years. Newer companies often perform terribly in a high interest rate and rising interest rate environment. Unfortunately for Palantir, this time is no different. By the end of 2022, realized and unrealized losses on its investments had reached approximately $345 million -- yikes!
Should you buy it?
Palantir's stock trades at a price-to-sales (P/S) ratio of 8.89, well below the median valuation of 16.62 that the stock traded at over the past two and a half years.
PLTR PS Ratio data by YCharts
Aggressive investors might consider the stock undervalued as Palantir is still at a very early stage of its opportunity in AI. For example, it has only penetrated 1.6% of its 2020 estimated total addressable market (TAM) of $119 billion. And the addressable market has likely grown since the company first estimated that TAM. In addition, demand for its platform is temporarily depressed by a poor economy, and once demand rebounds, the market will likely value this stock much higher.
If you are an aggressive investor who understands the risks, today is an excellent time to consider buying Palantir for its massive potential upside.
