Palantir Stock (NYSE:PLTR)
Palantir Technologies (NYSE:PLTR) is currently in an interesting position for potential investors. Because it is a high-growth stock, it is more sensitive to overall economic conditions and business cycles. Palantir stock was trading at around $17.5 a year ago, with a P/S ratio of 20x. To put things in perspective, Google (NASDAQ:GOOGL) trades at a 5x P/S ratio on average. PLTR’s stock price has dropped by about 60% to the current $6.6 range since 2022. Many of the sharp declines occurred at extremely high selling volumes.
Such a large price correction significantly deflated its bubble valuation, and there are many positives to be said about Palantir. First, the stock’s valuation is much more reasonable due to the previously mentioned 60% price decline. It has a P/S ratio of 7.3x. It is undeniably still quite expensive (Google currently trades at a 4.2x P/S ratio). However, a 7.3x P/S is no longer in an alarming bubble. Second, the potential for business growth is quite strong, particularly when/if overall economic conditions improve. The government sector is a significant and stable source of revenue. And the core business of Palantir is to develop and deploy software platforms that can serve as the central operating systems for its large government clients. One recent example is its collaboration with Lockheed Martin (NYSE:LMT) to accelerate the development of Aegis and the Navy’s future integrated combat software system.
However, there are some challenges. I will delve deeper into the stock’s positives and negatives in the following sections. However, for various reasons, stock prices will remain trapped in a single-digit trading range in the near future. My overall thesis is that long-term investors should wait for better opportunities. Swing traders, on the other hand, should brace themselves for a trading window between $5 and $10 in the coming year or so.
Palantir’s Positive Aspects
As previously stated, there are numerous positives to be said about Palantir.
For starters, Palantir has a low-capital business model. The following plot, for example, shows PLTR’s total depreciation and amortization (DA) and its CAPEX expenditures over the last few quarters. I’ll use these to estimate its maintenance and growth CAPEX spending in this section. Details about these concepts and their distinctions can be found in my previous articles. As can be seen, its DA was only about $12 million per quarter in 2022, and its CAPEX was only about $5 million. PLTR takes the capital-light model to its logical conclusion for a company with more than $450 million in quarterly revenue.
Second, because of its highly capital-light business model, the company’s true economic earning power, or owners’ earnings (OE), is significantly higher than its accounting earnings (i.e., the commonly quoted EPS). As a result, its PE multiple is lower than it appears when calculated using its OE rather than the accounting EPS.
As detailed in his book Value Investing, the Greenwald method was used to calculate its OE. As you can see, PLTR’s OE has outperformed its accounting EPS. And, despite accounting EPS remaining in the red, the OE has turned positive and has remained positive since the March 2021 quarter. On a TTM basis, my estimate for its OE in the most recent quarter of September 2022 is around 6-7 cents per share.
Palantir’s Disadvantages
However, there are some drawbacks. As previously stated, the government sector is a critical and stable source of revenue for Palantir. However, during periods of economic uncertainty, such as the one we are currently experiencing, its major government clients are subject to some uncertainties. Budget constraints, policy changes, and the possibility of a full-fledged economic recession are among the uncertainties. The timing and size of any new deals can be difficult to predict, and contract renewals are not guaranteed. It has acknowledged the problems. And management is attempting to diversify its revenue sources by attracting private-sector customers. These initiatives, however, are still in their early stages.
The uncertainty in earnings is reflected in the consensus estimates. The last three months’ earnings revisions reflect a rather bleak outlook. As can be seen, only one analyst submitted an upward EPS revision, whereas seven analysts submitted downward EPS revisions. Furthermore, downward revisions are substantial, ranging from 72% to 30% in the next 1 or 2 years.
Second, its current PE multiples still need to be lowered. As previously stated, the recent correction has reduced its P/S multiple to 7.3x, which is still roughly 2x higher than the overall market. In terms of PE multiples, the valuation is simply unsustainable. Because of its negative EPS, as previously stated, its TTM PE is meaningless. Its FWD PE is 142x in FY1 and 38x in FY2. Such private equity investments are expensive in absolute terms and compared to peers such as Trade Desk (NASDAQ:TTD) and Google.
As previously stated, its accounting ESP understates its owner’s earnings consistently. Even when we consider its PE multiple on an OE basis, its current PE remains in the high teens ($6.6 share prices on 6-7 cents of OE per share TTM). Even if its prices fall to $5, the lower bound of my forecast price range, its OE PE would still be greater than 70x.
Other Dangers and Closing Thoughts
Aside from the risks discussed above, PLTR’s financial strength is also a cause for concern. It has a weaker financial position than companies like GOOGL. Compared to smaller and less-mature players like Trade Desk and Tyler Technologies (NYSE:TYL), its financial strength is noticeably weak. Altman’s Z-score currently hovers around 0.45 (compared to 3.9 for TTD and 2.33 for TYL). A Z-score of around 3 is considered safe, while a score of less than 1 is regarded as a red flag.
To summarize, given the above uncertainties, Palantir stock price will remain in the single digits for the next year or so. As a result, my overall impression is that the stock is best suited for speculative swing traders.
Featured Image: Megapixl @ Burdun
