Palantir Technologies (PLTR -1.87%) has been on fire in 2023, driven higher by the excitement surrounding artificial intelligence (AI) and a broad rebound in technology stocks. Shares of the data mining and AI specialist are up 159% so far this year, nearly 10 times the 16% gains of the S&P 500. This is in stark contrast to its performance last year, when the stock lost more than 64%.
There's no question that the soaring demand for all things AI and Palantir's undisputed expertise in the field have been the driving force fueling the stock's rise.
The company's long track record of developing AI tools goes back two decades, long before the current explosion of interest in these next-generation algorithms. Palantir has also delivered consistently improving financial results this year, which suggests the macroeconomic headwinds that weighed on the company last year may finally be easing.
What does this mean for investors who sat out Palantir Technologies' recent surge? Should they buy now in anticipation of further gains or avoid the stock because its frothy valuation could lead to a steep decline? Let's take a look to see what the evidence suggests.
Image source: Getty Images.
What dragged Palantir stock down last year?
In many ways, 2022 was a year like no other, and it was primarily defined by the macroeconomic headwinds that battered the tech sector. Businesses reacted to the challenging landscape by cutting back on all non-essential spending, and data analytics was among the areas hardest hit.
There's a compelling argument that data gives managers the information necessary to make informed decisions. Still, when faced with the worst economic conditions in over a decade, many chose the path of least resistance.
These factors wreaked havoc on Palantir's results last year. The company still managed to increase revenue by 24%, but that paled in comparison to the 41% gains it delivered in 2021. The sharp deceleration of sales growth caused some investors to panic, but it's not uncommon for businesses to rein in spending in response to difficult conditions. Furthermore, history shows that once circumstances improve, historical spending patterns resume.
Investors should also remember that while Palantir didn't go public until 2020, the company has been creating custom data mining and AI solutions for 20 years, so its seasoned technology is leagues ahead of would-be rivals who merely claim to have AI "expertise."
As a result, Palantir has a decided advantage when businesses move to adopt AI.
What could drive Palantir stock higher?
One of the most significant developments for Palantir this year (the AI revolution aside) is the company's consistently improving financial picture.
When the company reported its second-quarter financial results, management noted that Palantir was profitable for the third consecutive quarter and expects to remain in the black every quarter this year. The company continues to generate operating and free cash flow, which suggests its profits will continue. Palantir also increased its full-year guidance and instituted a $1 billion stock buyback.
Yet it was management's commentary regarding the surging interest in AI that should have investors most excited. The company's second-quarter shareholder letter provided an update on Palantir's Artificial Intelligence Platform (AIP), which debuted just last quarter. More than 100 organizations have already adopted the system, and the company is in discussions with 300 more.
The demand is being driven by companies looking to apply AI functionality to their existing systems and proprietary data. CEO Alex Karp said, "As a result, the demand for AIP is unlike anything we have seen in the past 20 years." Businesses are scrambling to capture the productivity gains made possible by generative AI.
Estimates vary greatly, but the general consensus is that trillions of dollars are at stake. Among the most bullish on the technology is Cathie Wood, CEO of Ark Investment Management. In the firm's Big Ideas 2023 report, Wood suggests a fourfold increase in the productivity of knowledge workers and a tenfold increase in coding productivity. Wood estimates that AI software could generate $14 trillion in revenue by the end of the decade.
This suggests that those who fail to adopt AI could be ceding a critical competitive advantage.
How to approach Palantir stock now
I'd be remiss if I didn't address the elephant in the room. The run-up in Palantir's stock price this year has caused a commensurate increase in its valuation. The stock is currently selling for roughly 18 times trailing sales and only a slightly better 13 times next year's sales, so it has plenty of growth baked in.
Still, while value investors will likely balk at the valuation, it is far below Palantir's historical average and a reasonable price to pay for a company that's at the cutting edge of a massive secular tailwind.
Furthermore, Palantir is expected to generate double-digit revenue growth, and its earnings per share are expected to quadruple between now and 2024.
Given the rapid and accelerating adoption of AI and Palantir's chosen area of expertise, these growth estimates may well be conservative.
