After Earnings, Is Palantir Stock a Buy, a Sell, or Fairly Valued?

Palantir PLTR released its third-quarter earnings report on Nov. 2. Here’s Morningstar’s take on Palantir’s earnings and stock.

Key Morningstar Metrics for Palantir

• Fair Value Estimate: $13.00
• Morningstar Rating: 2 stars
• Morningstar Economic Moat Rating: Narrow
• Morningstar Uncertainty Rating: Very High

What We Thought of Palantir’s Q3 Earnings

• We saw substantial upside to Palantir’s profitability. For example, we were projecting 25% adjusted operating margins, and the firm reported 29%. This also informed our fair value increase of $2. Other notable items were strong U.S. commercial deals and strength, which again point to customer interest in the Artificial Intelligence Platform, or AIP.
• Our thesis remains intact: Palantir is a solid company with a great AI portfolio, but its fundamentals don’t warrant an $18 price tag for its stock. We do have a price target of $18 in our bull case, but its growth estimates are well north of the highest consensus estimates on the street. In short, if you are very bullish on Palantir and think the company will be able to monetize AIP incredibly well while turning over strong cash margins/profitability, it may be the stock for you.
• Palantir is now eligible for inclusion in the S&P 500. This could be big, bringing more institutional ownership via passive stock-index funds and institutional investors that are benchmarked to the index.

Fair Value Estimate for Palantir

With its 2-star rating, we believe Palantir’s stock is overvalued compared with our long-term fair value estimate.

Our fair value estimate for Palantir stock is $13 per share. We forecast the firm’s revenue to rise at a 23% compound annual growth rate over the next five years as it expands both government and commercial operations. We expect the majority of this top-line growth to be driven by commercial clients as the firm seeks to broaden its commercial client base. While government clients can be sticky, large government contracts create lumpiness in revenue. As a result, Palantir’s shift to more commercial clients will let it create a more ratable revenue mix. We also expect the firm to continue expanding sales within its existing client base. We view Palantir’s strong net retention rate as an indicator of this.

Palantir’s GAAP gross margins have varied widely over the past few years, with 2022 gross margins clocking in at 78.6%. As the firm grows, we expect gross margin expansion. Our forecast is based on Palantir landing higher-margin commercial contracts and scaling its operations (thereby leading to its costs being divided over a larger base). We see this phenomenon across our coverage as software companies can distribute their costs over an increasing revenue base, driving the cost of sales down as a fraction of sales. As a result, we are modeling GAAP gross margins to expand to the low 80% range over our 10-year explicit forecast. Palantir has spent heavily on research and sales in the past.

Read more about Palantir’s fair value estimate.

Palantir Historical Price/Fair Value Ratio

Ratios over 1.00 indicate when the stock is overvalued, while ratios below 1.00 mean the stock is undervalued.

Economic Moat Rating

We assign Palantir a narrow economic moat owing primarily to strong switching costs associated with its platforms, and secondarily to intangible assets in the form of strong customer relationships the firm has built up over the years.

We think that Palantir’s two main platforms, Gotham and Foundry, both benefit from high customer switching costs, as evidenced by the firm’s strong gross and net retention metrics. Palantir has exhibited strong customer growth while diversifying its business from lumpy government contracts toward commercial clients. As a result, although we forecast a couple of more years of hefty operating losses, we ultimately expect the firm to generate excess returns over invested capital on the whole over the next decade.

The primary use case for Palantir, across its government and commercial clients, is leveraging data to develop insights and create efficiencies in an organization’s operations. Gotham and Foundry serve the government and commercial end markets, respectively. More recently, the firm has launched a third platform, Apollo, which ensures clients have continuous delivery of Gotham and Foundry irrespective of whether they have deployed these platforms on the cloud or on-premises.

Within modern large organizations (both commercial and government), Big Data is pervasive. According to our estimates, the amount of total digital data stored worldwide will increase to 620 zettabytes (a zettabyte is a billion terabytes) by the end of the decade, indicating a 10-year CAGR of 28%. Against this backdrop, large organizations are increasingly interested in gleaning insights from the copious amounts of data they’re producing/consuming. While this shift to leverage data to drive efficiencies may seem intuitive, organizations often struggle to turn this data into tangible improvements.

Based on various industry reports, we contend that only a minority of artificial intelligence and machine learning analytical solutions deliver business outcomes. Palantir’s platforms assist large organizations in making sense of this data while allowing its clients to use any data type (structured and unstructured) from any location (spreadsheets, CRM systems, hyperscalers, on-premises, and Internet of Things sensors).

Read more about Palantir’s moat rating.

Risk and Uncertainty

We assign Palantir a Very High Uncertainty Rating because of some key risks that we view as potentially impeding its growth trajectory.

While Palantir has landed high-value commercial and government clients over the years, we have found the executive team’s execution to be questionable at best. The firm’s sales strategy has led to relatively poor customer acquisition, despite being in the commercial space for many years, Palantir’s commercial customer count is only slightly more than 200. While the firm has pivoted to a module-based sales model that should bolster commercial customer additions, execution against this strategy remains to be seen.

Our lack of confidence in the executive team is highlighted by the firm’s special-purpose acquisition company investment program, which led to more than $300 million of losses as investments in early-stage companies went south as markets recalibrated in 2022. In our view, these investments, based on a quid pro quo of the investees becoming Palantir customers, were a bit reckless.

Read more about Palantir’s risk and uncertainty.

PLTR Bulls Say

• Palantir has strong secular tailwinds behind its back, as the artificial intelligence/machine learning market is expected to grow rapidly due to the exponential increase in data harvested by organizations.
• With products targeting both commercial and governmental clients, Palantir has a distributed top line which is insulated by the firm’s noncyclical governmental revenue during lean times.
• Palantir’s focus on modular sales could potentially lead to substantially more commercial clients, which the firm could subsequently upsell.

PLTR Bears Say

• By not selling to countries/companies that are antithetical to Palantir’s mission and cultural values, the firm has self-restricted its growth opportunities.
• It will likely be several years before Palantir will achieve GAAP profitability.
• Palantir’s executive team has made questionable strategic decisions in the past. While past performance isn’t necessarily indicative of future results, we highlight these missteps as cautionary tales for potential investors.

This article was compiled by Brendan Donahue.