Palantir (NYSE:PLTR) has gained a lot of attention among investors as its initial public offering (IPO) and trading debut in 2020 delivered fast and big profits. In my latest article about Palantir stock, I mentioned three key reasons to avoid it.
These key reasons, in brief, were the valuation, the business risks of relying on too few major customers such as the U.S. government and the financial performance of the stock. Has my investment thesis changed since? The answer is no. There has not been any material event related to the fundamentals that could justify any change to my financial analysis.
For this article on Palantir stock, I will focus on 10 key risks that can be crucial to future stock performance — important factors you should consider before buying any Palantir shares. Most of these 10 factors are listed by the company in the prospectus it filed with the Securities and Exchange Commission (SEC) informing the public investment community.
Risk Factors for Palantir Stock: 1. Lockup Period Ends Soon
Palantir stock has a three-month return of about 182%. It made its trading debut in late September 2020. Palantir’s IPO lockup period ends in mid-February 2021, near the date of its next earnings release. This means two additional sources of expected increased stock price volatility. Insiders will be able to sell their shares, adding extra supply to the stock. Profit taking is also very possible.
2. Risk of Unsustainable Revenue Growth
The financial results for the third quarter of 2020 were positive, showing considerable revenue growth. Revenues hit $289.4 million, up 52% year-over-year and “full-year 2020 revenue guidance raised to a range of $1.070 billion to $1.072 billion, up 44% year-over-year.”
But is this growth and momentum for revenues sustainable? Any earnings miss or slowdown in this revenue growth can add selling pressure to the stock.
3. China Business Operations
The company has stated that it intends not to have any business operations in China. Excluding this large market may harm its revenue and profitability. Growth prospects may be limited, and the company may be kept behind its competitors who choose to have business operations in China, losing the edge or competitive advantage.
4. Commercial Business Competition
The company aims to grow its commercial business and not just rely on government contracts. This is good news, which will focus mainly on the health care, energy and manufacturing sectors as commercial contracts. But competition in these different sectors is expected to be very intense for Palantir to gain any significant market share.
5. Regulatory Risks
Having a business model that is now primarily based on government contracts, the company must always adhere to the laws and regulations related to them. This is an extra business cost, as it may incur financial audits and investigations. Having a business with government agencies means that any potential breach of regulation laws could have significant effects on Palantir’s business operations. And there is also the need for specialized personnel to consistently monitor the latest local and international laws.
6. Investments in Research and Development for New Technologies
The company mentions that there is a continuous need to invest in new technologies to support its customers’ needs. This means further increases in research and development (R&D) expenses, which have a direct effect on operating income and profitability. The company must find a balance to control these expenses as they increased from 2018 to 2019. And I expect a further increase in the future.
7. Covid-19 Outbreak
The pandemic has disrupted businesses, daily lives and the way people work at home. It also has hurt Palantir’s business and operations. The company mentions travel expenditures, which are expected to increase in the future. It is still too early in 2021 to measure the actual negative impact of the pandemic on economies and financial markets globally. There are lockdowns in many countries, and delays in the global vaccination plan may be a negative factor, not just for Palantir but for the global economy.
8. Contracts With Governments Pose Significant Security Risks
Palantir has government contracts that require customization and high-security measures to avoid any leakages of important information. Any breach of important information could have a major negative impact on the company and its stock. From cyberattacks to investing in intellectual property and protecting important data, any security incident involving classified information could be a very serious problem both financially and legally for the firm’s reputation.
9. Tax Laws
Any tax changes can materially affect Palantir’s tax obligations, financial condition, results of business operations and cash flows. For example, the Tax Cuts and Jobs Act (“Tax Act”) was enacted on Dec. 22, 2017. The implications included a change in how the U.S. imposes income tax on multinational corporations.
Another key factor is that the U.S. government may start increasing the tax rates to U.S. corporations, reversing the previous tax cuts by President Donald Trump’s administration.
10. Foreign Currency Exchange Rate Fluctuations
Global operations and cash flows are subject to foreign currency exchange rates. Palantir wants to expand its non-U.S. operations, and, in my opinion, it should consider financial derivatives for hedging the foreign currency market fluctuations. If no hedging is used, the risk of lower revenues from global operations could be severe for Palantir stock.
On the date of publication, Stavros Georgiadis, CFA, did not have (either directly or indirectly) any positions in the securities mentioned in this article.