I’ll admit it up front: I’ve been wrong so far about Palantir (NYSE:PLTR). Completely wrong. Indeed, I wrote toward the beginning of November, five weeks after the company went public, that investors should let the dust settle. Almost immediately, PLTR stock went on a tear. Within weeks, it had more than tripled.
I may be wrong again, but buying this rally seems foolhardy, even with sideways trading over the past four weeks.
Palantir is a fascinating company, and an intriguing potential investment at the right price. But it’s hard to argue that $28 is the right price, particularly with still-key questions unanswered.
When Palantir went public at the end of September via direct listing, investors mostly shrugged. PLTR stock did open its first day up nicely from its so-called “reference price” of $7.25, but drifted down as the day went on. From there, it flat-lined for the next several weeks.
The rally began in earnest after Election Day, as PLTR gained 37% in three sessions. It’s still not clear entirely why that happened. It’s possible that surprising Republican strength in Senate races perhaps cheered investors.
Democratic control of all three branches of government presumably would have provided a stiff, multi-year headwind to a company controversial on the left. (Two races in Georgia remain undecided which technically could give Democrats control of the Senate, but that control would be tenuous.)
A Closer Look at PLTR Stock
But there’s another possible explanation. Election Day, for whatever reason, coincided with the start of a massive rally in small- to mid-cap stocks. PLTR stock admittedly wasn’t quite in that group then (and certainly isn’t now), but on the whole November trading definitely benefited higher-risk, higher-growth names. Palantir stock certainly is in that group.
In fact, it’s difficult to see another explanation. Third quarter earnings on Nov. 12 were solid, but don’t look like much of a surprise. PLTR did rally more than 8% the following day, but the stock had fallen 8% the day of the after-hours release. Nothing has really changed all that much since then.
That hasn’t stopped from PLTR from moving. Most notably, the stock gained 21% on Dec. 7 after the company announced a contract win with the Food & Drug Administration.
The gain added more than $5 billion to Palantir’s market capitalization — even though the contract was for three years at less than $15 million annually. That trading adds to the sense that the stock has become disconnected from the fundamentals.
PLTR Stock Gets Expensive
At $28, Palantir now has a market capitalization above $48 billion (using the share count from the most recent Form 10-Q filed with the U.S. Securities and Exchange Commission). That’s a massive number against the company’s revenue and profit base.
Notably, PLTR trades in the range of 33x next year’s revenue, based on 2020 guidance from the Q3 release and the company’s expectation of 30%-plus growth in 2021. Using this year’s adjusted operating income guidance of $130 million to $136 million, the multiple is a staggering 350x.
That adjusted figure excludes stock-based compensation which totaled $180 million in the first half even before the direct listing led to a sharp rise in Q3.
To be fair, those multiples aren’t necessarily outliers in this market. And for the best businesses, investors have been willing to pay up. The question at this point, however, is if Palantir indeed is one of the best businesses.
To be sure, Palantir is a good business. At this point, it’s established as much.
But where PLTR stock gets a bit dicey is in that valuation, and what it represents. Essentially, the stock is being valued like one of the best high-growth software plays in the market.
Relative to those names, Palantir actually has a slower growth rate. Meanwhile, the company hasn’t proven its business model is as attractive. As I noted earlier this year, many investors and analysts still see Palantir as more like a consulting firm than a software play.
The data analysis Palantir provides requires significant, and costly, human assistance.
We’ll see if the Foundry platform changes that. Clearly, bulls believe that it will. But that still leaves a big potential problem.
PLTR already is being valued as if it is a software company, with the associated potential for margin expansion as revenue grows. And so if that case is correct, there doesn’t seem to be much upside here. If the case is incorrect, the downside could be swift and steep.
That’s why investors like myself are skeptical of this rally. Analysts are too: PLTR has tanked twice in recent weeks after downgrades from Wall Street firms. Those firms are making legitimate cases, and they’re not alone: the average Street price target sits near $14, barely half the current price.
Bulls could legitimately respond that analysts have been wrong before. They have. So have I. But the risks, and the worries, are real. Palantir still has a lot to prove. Palantir stock hardly seems valued as such.
On the date of publication, Vince Martin did not have (either directly or indirectly) any positions in the securities mentioned in this article.