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Background
Palantir Technologies Inc. (PLTR, Financial) is a storied software and services company with, famously, the CIA's venture capital arm In-Q-Tel as an early investor. The company remained in private ownership for an unfashionably long period, some 17 years, before going public via a direct listing in late September 2020. The company attracts controversy because of what it does - provide data analytics software and services to government organizations, civilian and military alike.
The stock itself has been no less controversial. The company's choice of a direct listing - lauded by some as being good for investors because of the lower Wall Street fee burden versus a traditional underwritten initial public offering - meant that no insider lockups applied, and there was incessant insider selling for a long time after the listing as a result. The stock hit an all-time high of $45 in January 2021, before beating a hasty retreat to a low of $6 in December 2022. Of course, when the stock was riding high, it was a retail favorite; and at the lows, no one would be seen on social media wanting to own the stock. Opposite Day, as always, applied. Since the lows, the stock has more than tripled in less than a year. Below we consider whether the stock has a bright future, or whether a return trip to the lows is on the cards.
Fundamental analysis
Though you will see Palantir referred to as a cloud business, with all that implies about revenue visibility, in fact the company's financials more closely resemble an old-line enterprise software business in the mold of an Oracle (ORCL, Financial) or SAP (SAP, Financial). This is due to the nature of the customer base. Each customer requires highly specific applications, which, whilst built around core Palantir technologies, look very different in the field. The health care application required by the U.K. government is unlikely to look very much like the defense applications required by the U.S. federal government. Palantir supplies both.
Further, the degree and nature of integration with other applications in each customer environment is going to be very different each time. As a result, the revenue line has a much more contingent nature than a typical subscription-oriented cloud business such as DataDog (DDOG, Financial) or Adobe (ADBE, Financial). You can see this in the low percentage of trailing 12-month revenue represented by the total order book (all purchase orders signed by customers, the "remaining performance obligation" or RPO) and by the already-invoiced, yet-to-be-recognized-as-revenue element of RPO, being deferred revenue. And that means that the company's propensity to miss guidance once in a while is that much higher than for a more predictable business, which, of course, implies volatility for the stock.
Let's take a look at the numbers up to and including the third quarter reported last week.
Palantir financial summary - Source: Company SEC filings, YCharts.com and Cestrian analysis
Highlights and lowlights:
- Revenue growth accelerated to 17% year over year in the third quarter, taking trailing 12-month revenue growth to 16% (down from a peak of 41% in December 2021). The guide is for 18% growth in the fourth quarter, which would see trailing 12-monthrevenue growth flatten out at 16%, arresting the declining growth rate that has been in place since the IPO.
- Gross margins ticked up to 80% on a trailing 12-mont basis, which is excellent for a company with this business model.
- Trailing 12-month Ebitda margins hit 25%, a record high for the company.
- Trailing 12-month unlevered pretax free cash flow margins also hit a record high at 18% (note, again, this is a good cash flow margin for this type of business model).
- The balance sheet is rock solid with $3.3 billion of net cash.
- Per commentary above, future revenue visibility is weak - deferred revenue growth is slowing and there is not much of it in the first place, and the same is true for remaining performance obligations. (Note, if any of this is unfamiliar to you, ask in the comments field below - we read all such comments and endeavor to respond as quickly as we can).
Let's turn to valuation multiples.
Palantir valuation analysis - Source: Company SEC filings, YCharts.com and Cestrian analysis
It would be difficult to convince yourself to buy the stock with those multiples. On any measure, the stock is expensive on fundamentals; not least because most likely the company is at or near peak sustainable cashflow and Ebitda margins, and nothing in the RPO or deferred revenue performance points to any near-term improvement in revenue growth.
In our own work, company fundamentals and valuation analysis is a useful input, but we find much greater success by combining it with stock technical analysis. Let's see how Palantir's stock looks on its chart.
Technical analysis
You can open a full page version of this chart by clicking here.
Palantir stock chart - Source: Cestrian Capital Research and TrendSpider
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Allow us to explain the kaleidoscope you see above.
The stock commenced trading in the $10 zip code and, as mentioned above, reached a high of $45 in short order. It then entered a long period of sideways action in the $20s range all through 2021 - this is a typical distribution pattern (where retail buyers provide exit liquidity to institutional and management sellers), which turned out to be the case. Once the supply of buyers was exhausted, the stock hit freefall before finding support in the $6 region in May 2022.
The stock then commenced institutional accumulation - typical sideways action at the lows - for a year, from May 2022 to May 2023, whereupon the name launched up into our Markup Zone. This action was seen time and time again in high-growth tech stocks, accompanied all the while by endless “it's all over for tech” narratives in the financial media.
The stock looks to be in a five-wave pattern up, an impulsive move that commenced in December 2022, put in a Wave 1 high a little above $10 in February 2023, a Wave 2 low in March 2023, a Wave 3 high of $20 in July 2023 and a Wave 4 low in the $13 range in September.
We anticipate a Wave 5 high in the $22 to $25 range (that's the 0.618 to 0.786 Fibonacci extensions of the Waves 1-3 combined, placed at the Wave 4 low, a typical Wave 5 termination zone) sometime early next year.
Rating
We rate Palantir stock at hold since it's squarely in our Markup Zone, and whilst we can see upside to that $22 to $25 range (and, for the patient, beyond that - probably after another tumble), that's modest upside from here compared to the risk in our view. We rated the stock at accumulate in the $5 to $10 range in 2022 and early 2023, matching institutional behavior (this being the goal of our chart and rating system). If you take a look at the volume by price bars - that's the gray bars on the right hand side of the chart above - you can see there is a lot of unsold inventory in the $22 to $28 range - that is likely to be retail shareholders who were busy buying up stock from selling institutions and managers back in 2021. They are likely to want to unload at or close to cost - most will not have the patience to wait for future gains. This supply of stock will, in our view, provide resistance for some time. If and when the stock can climb over $28, the air becomes thinner and we think the rate of ascent can increase.
So, hold rating; if trading short term, we believe an exit in the $22 to $25 range would be sensible, if holding for the long term then it is certainly possible that new highs can be made, but we think that may be some years away.
Alex King, for Cestrian Capital Research Inc. - 8 Nov. 2023.
