Palantir is a company that came onto my radar as it was one of the big direct listings of 2020.
The stock has also garnered somewhat of a meme status on different reddit communities such as r/wallstreetbets and r/stocks as a lot of fellow investors are hyping up the stock to be one of the shining lights of 2021.
So is Palantir a good investment?
The stock since debuting on the public markets has gone crazy, it debuted at around 9 dollars per share and in the space of around 2 months rocketed up to around 30 dollars per share.
Whilst this is super exciting for investors that got in early, previous performance of a stock doesn’t necessarily predict future performance.
In this post I want to cut through the noise and look a bit deeper into Palantir and see if it’s a good investment.
Overview of their business
Palantir is a big data analytics company. They operate in both the private and public sector and have been around for 17 years. They were founded by Peter Thiel who was also the founder of Paypal and one of the early investors in Facebook.
Palantir was founded to assist government agencies (think CIA and FBI) to allow them to bring multiple databases of information together and use this to provide more valuable insights and predict behaviours.
The company operates as a B2B software provider and mainly focuses either on large government agencies or Enterprise organisations.
They have been tied to the CIA as they apparently their software helped in the assasination of Osama Bin Laden.
More recently, Palantir were awarded a contract with the NHS (National Health Service) in England to help aggregate data relating to the Covid-19 pandemic which helps them to monitor bed capacity across Trusts and monitor the rollout of the Covid Vaccine.
Primarily the majority of their revenue has come from these government contracts but in the past few years they have expanded their offering in the private sector with their “Foundry” product, which is apparently able to be rolled in out across a large enterprise in about 6 hours.
In September 2020 they closed a five-year contract renewal with a customer in the aerospace industry that is apparently worth $300 million in total contract value.
The Bull Case for an Investment in Palantir
The data analytics market is set to grow from a market size of 37 billion in 2018 to over 105 billion by 2027.
This puts Palantir in a great position to capitalise off of this.
Baked into their current valuation is an expectation that they will continue to grow aggressively so the tail winds of the overall market size increasing will benefit them.
Furthermore, the Covid-19 pandemic has more generally accelerated the trend of digitisation across the world and from this companies need to leverage data to make business decisions.
Palantir state that only in the past 3 years that they have started to invest into sales and marketing efforts to fuel their growth. Prior to this, they relied on word of mouth and networking to get their contracts.
As their customer base is generally large government agencies and enterprise companies, it’s no surprise that they only have around 100 customers to date. This has some positives and negatives associated with it.
On one hand, having so few customers means there is significant room to grow. A lot of the contracts they have are for long periods of time and with stable government organisations, those of which are not going to default on their payments.
By embedding deeply into organisations, their software will be “stickier” than others and thus it should mean they retain these clients for long periods of time.
From their recent earnings statement, they grew their average revenue per customer from 4.2 million per year to 5.8 million per year, representing a growth of 38% yearly which is quite impressive.
If they can continue to add new customers and grow revenues in the same fashion then they might be able to keep up or exceed analysts expectations which would make Palantir a pretty good investment.
They also have some large institutional investors including Morgan Stanley and the ARK innovation fund, which was the top performing active ETF of 2020. The share price actually rallied around 8% when Cathie Wood’s Fund bought shares.
I think Palantir has a bright future as I think in our modern world, data is only going to become more important and because data is so valuable now (think about how google’s business model basically runs off data alone), they have a lot of room to charge customers large sums of money.
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The Bear Case for an Investment in Palantir
The stock trades are a pretty high valuation currently, at around a price to sales ratio of 48 at the day of publishing this article.
I think in this case, price to sales is a metric that is more relevant than say price to earnings or EBITDA margins because the company is not profitable at the moment as they are investing most of their money money into sales, marketing and product development to fuel growth.
This is typical for a company that is trying to become a leader in a market.
A price to sales ratio of 48 is pretty insane, to put this in perspective most traditional SaaS companies historically have traded at a price to sales ratio of around 10, so if you have a company that is 5x this, it means you need to be growing fast consistently otherwise the share price will eventually trade sideways or down.
As the old saying goes, the stock market is a voting machine short term but on a long term its a weighing machine. Time will tell if Palantir can justify the current valuation.
Analysts currently have consensus that the stock is currently overvalued and that it’s one year target price is 17.83.
Having said that, most stocks at the moment are quite expensive on a relative basis.
This is the historical Price to Earnings ratio of the S&P 500. As you can see, we are nearly at the same valuation as the .dom bubble and on a historical basis stocks are super expensive. Palantir is no different.
Whilst I don’t think necessarily it’s a deal breaker, you need to factor in the risk you are taking vs the reward you are likely to get. On this stock I feel like there is less upside than the risk I am willing to take as an investor.
One of the other things to consider with Palantir is because it was a directly listed stock, it means for the founders and shareholders of the company there is a lock up period where they can’t sell their shares for 3 months after the company goes public. That expires in February 2021 and so it will be quite interesting to see if a lot of the shareholders cash in on the high valuation.
The company has been private for 17 years now so I think a lot of their staff will want to cash out some of their shares, especially if the valuation is inflated.
My Strategy for Investing in Palantir
Overall I am bullish long term on Palantir’s business model and their product and I think as a long term investment, it’s a company that could provide some good returns.
However from an investment perspective I think the valuation is too expensive for me currently. Palantir is on my watch list and I will be following their earnings reports closely to see if they can maintain their revenue growth and gain more market share in the private sector.
With the current share price at 25.64 USD at the time of writing, I will be waiting until the lockup period ends and will try enter the market if the share price goes below 19-20 dollars.
Even at this valuation the price to sales ratio is pretty high but for a company who have the potential to be market leaders, which I think they can, at this price I would start a small position and then add over time if they continue to deliver good results. If you are interested in a company that I think offers good value check out my analysis of Disney here.
If you are interested in investing in Palantir and don’t have a trading account, I recommend FreeTrade. They have no brokerage fees and it’s a really easy app to use.
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Disclaimer: This article is written for entertainment purposes only. I advise you to seek out professional advice if you are looking to invest and do your own research.