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Palantir Technologies Inc Cl A(PLTR-N)

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3 Reasons to Buy Palantir, and 3 Reasons to Sell

Motley Fool - Sun Sep 17, 5:52AM CDT

Palantir(NYSE: PLTR) made its public debut through a direct listing nearly three years ago. The data mining and analytics company's stock started trading at $10, soared to its all-time high of $39 the following January, and now trades at about $15.

The bulls were initially impressed by Palantir's established presence across U.S. government agencies, the expansion of its commercial business, and its goal of growing revenue by at least 30% annually from 2021 to 2025. However, the bears rushed in as growth cooled off and rising interest rates popped its bubbly valuation.

Palantir remains a divisive stock after that big pullback. Let's review three reasons to buy the company -- and three reasons to sell it -- to see if it's a worthwhile investment.

A soldier uses a laptop on the field.

Image source: Getty Images.

The three reasons to buy Palantir

The bulls still love Palantir because it's an artificial intelligence (AI) play, its margins are expanding, and its free cash flow (FCF) is rising at an impressive rate.

Palantir operates two main platforms: Gotham for government agencies and Foundry for its commercial clients. Both platforms gather large amounts of data from disparate sources and then analyze all that information to help organizations make smarter decisions.

This June, Palantir added new AI features to that ecosystem with its AI Platform, which helps clients build new AI apps and analyze data with large language models. The company also expects the AI arms race across the government and commercial sectors to drive the market's long-term demand for its data-crunching services. In other words, the market's interest in AI stocks might light a fire under its stock for the foreseeable future.

Palantir's revenue growth has cooled off since its public debut, but its adjusted operating margin expanded from 17% in 2020 to 22% in 2022 before rising to 25% in the first half of 2023. It's also remained profitable on a generally accepted accounting principles (GAAP) basis over the past three quarters and expects to stay in the black for the foreseeable future. A fourth consecutive quarter of GAAP profitability would make it eligible for inclusion in the S&P 500 -- and joining that benchmark index could stabilize its price by bringing in big funds and institutional investors.

Palantir's adjusted FCF margin improved from negative 25% in 2020 to positive 28% in 2022, then expanded again to positive 27% in the first half of 2023. To capitalize on that rapid FCF growth, the company recently authorized a new $1 billion buyback plan -- which suggests management believes its own shares are still undervalued.

The three reasons to sell Palantir

The bears argue that Palantir's sales growth is unimpressive, its valuation is still too high, and its questionable deals with special purpose acquisition companies (SPACs) raise red flags regarding its business strategies.

Palantir's revenue rose 47% in 2020 and 41% in 2021 but grew a mere 24% in 2022. The company only expects its revenue to rise 16% in 2023. It mainly attributes that slowdown to the uneven timing of its government contracts and macro headwinds for its commercial business, but competition from other data mining platforms, like Alteryx(NYSE: AYX), and internal U.S. government platforms, like RAVEn, could be exacerbating that pain.

Palantir still trades at 58x forward adjusted earnings and 15x this year's sales. Alteryx is growing slower but trades at just 28x forward earnings and 3x this year's sales. Therefore, it seems like the AI hype is inflating Palantir's valuation -- even though its new AI Platform probably won't significantly boost its near-term sales or profits.

Lastly, the company still faces multiple investor lawsuits regarding its investments in nearly two dozen start-ups that merged with SPACs throughout 2021 and 2022. To secure those funds, those start-ups were required to sign multiyear contracts with Palantir that either matched or exceeded the company's initial investments (between $10 million to $40 million).

Palantir secured over $700 million in contracts from its own SPAC-backed companies in this manner, which significantly boosted its reported revenue in 2021. But by the end of 2022, the average value of those start-ups had plummeted about 80%. The bears claim Palantir was merely trying to turn its own cash into revenue through speculative SPAC deals -- and that it pursued that reckless strategy to mask the slowing growth of its core businesses.

Palantir admits the ongoing class action lawsuits regarding those deals "could result in substantial costs and a diversion of our management's attention and resources" in its latest 10-Q filing. During its conference call for the first quarter of 2023, Palantir admitted its revenue from SPAC contracts had inflated the quarter-over-quarter growth of its U.S. commercial business by 15 points to 39%. It didn't disclose that eyebrow-raising figure again in the second quarter.

Which argument makes more sense?

Palantir's slowing growth, high valuation, and questionable business deals with subservient SPACs all make it a weak investment right now. It's made some good progress toward stabilizing its margins and profits but simply doesn't seem like a great investment when so many other high-quality tech stocks are still on sale.

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Leo Sun has no position in any of the stocks mentioned. The Motley Fool recommends Alteryx and Palantir Technologies. The Motley Fool has a disclosure policy.

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