The Nasdaq Composite is one of the most widely followed stock indexes in the U.S. The tech-focused index tracks the performance of more than 3,000 stocks listed on its exchange. The Nasdaq-100 is a subset of the index, tracking the performance of approximately 100 of the largest non-financial companies on the Nasdaq stock exchange. To be included in the Nasdaq-100, a company must meet the following criteria:
- Be listed exclusively on the Nasdaq exchange.
- Be highly liquid.
- Been listed on an eligible exchange for at least three full calendar months.
- A minimum of 10% of its outstanding shares must be available for trading.
- Must not have filed for bankruptcy.
The index announced its annual rebalancing on Dec. 13 after the market close. Palantir Technologies (PLTR -3.72%) was selected to join the Nasdaq-100, "which will be effective prior to the market open on Monday, Dec. 23." Since generative artificial intelligence (AI) went viral early last year, Palantir stock has surged 1,090%. Its decades of experience with AI made it the go-to for AI solutions, likely easing its admission to the index.
After its recent surge, some investors are reluctant to buy the stock, particularly given its frothy valuation. One Wall Street analyst believes that view is myopic. Let's review the circumstances behind Palantir's recent parabolic move higher and see whether there's additional upside ahead.
Image source: Getty Images.
AI before it was fashionable
Palantir was born from the rubble of 9/11, with the idea that the right AI algorithms could piece together seemingly unconnected bits of information that would uncover a terrorist plot before it could come to fruition. The company soon gained a following among the U.S. intelligence community and our allies, and military and law enforcement agencies quickly adopted its solutions.
Over time, the company expanded its offerings to bring its data mining, analytics, and AI know-how to enterprise customers, providing data-driven solutions. The advent of AI early last year brought customers in droves looking for solutions. Palantir swiftly developed a multipurpose tool to answer the call. The Artificial Intelligence Platform (AIP) was the fruit of its labor. By connecting AI to a company's operational data, AIP can provide real-time, company-specific solutions to real-world problems.
To counter the knowledge gap existing at most companies, Palantir created boot camps where customers work one-on-one with Palantir engineers to develop these custom-made solutions. Evident in Palantir's financial results, this removes the most common hurdle for businesses wanting to adopt AI.
Digital display
In the third quarter, Palantir generated revenue of $726 million, which grew 30% year over year and 7% sequentially. At the same time, earnings per share (EPS) of $0.06 soared 100%, marking its eighth consecutive quarter of profitability. As impressive as that is, it only tells part of the story.
Palantir's U.S. commercial segment, which includes much of its AIP revenue, grew 54% year over year, pushing its remaining deal value (similar to backlog) up 73%. When backlog is growing faster than revenue, it provides insight into future potential, which is rapidly improving. The segment's customer count also soared, jumping 77%.
Let's not forget Palantir's foundational government revenue, which grew 40% year over year and 15% quarter over quarter.
Another key indicator is the accelerating number of contracts the company is signing. In Q3, Palantir inked 104 deals worth at least $1 million. This included 36 deals worth $5 million or more and 16 worth at least $10 million. It's telling that many of these agreements were reached just weeks after a customer participated in one of Palantir's boot camps.
The company has likely only scratched the surface of the tidal wave of demand. According to global management consulting firm McKinsey & Company, the generative AI market is expected to be worth between $2.6 trillion and $4.4 trillion over the next 10 years. Palantir is well positioned to profit from these brisk secular tailwinds.
The elephant in the room
While there's little question Palantir has a bright future, some investors fear the stock has gotten ahead of itself, and Wall Street seems to agree. Of the 20 analysts who offered an opinion in December, only four rate it a buy or strong buy, nine rate it a hold, and the remaining seven rate it underperform or sell. Those who are bearish on the stock almost universally cite its valuation as the catalyst for their dower outlook.
The numbers seem to support that view. The stock is currently selling for 380 times earnings and 69 times sales -- both of which are egregious by any stretch of the imagination. However, the most commonly used metrics fall far short when evaluating a high-growth company. For example, Palantir's forward price/earnings-to-growth (PEG) ratio -- which factors in the company's accelerating growth -- clocks in at 0.63, while any number less than 1 is the standard for an undervalued stock.
Wedbush veteran tech analyst Dan Ives remains bullish, maintaining an outperform (buy) rating on Palantir with a $75 price target, though the stock recently eclipsed that target. The analyst expressed "increased confidence in the game-changing AIP strategy with use cases for AI taking hold over the next 12-18 months." He went on to say that Palantir will see "unprecedented demand" as more enterprises adopt and expand the use of the company's AI solutions.
Furthermore, while Palantir currently has a market cap of roughly $172 billion, Ives believes Palantir could be "the next Oracle." Given Oracle's (NYSE:ORCL) market cap of $494 billion, that suggests potential upside of 188% for Palantir. While that's a bold proclamation, it does illustrate the opportunity that exists. To be clear, that vision will take some time to play out if it does.
I'm not unsympathetic to the conundrum represented by the conflicting views. For those who still feel Palantir is too expensive, one strategy is to buy a small position that won't break the bank and add to it next time the stock takes a nosedive -- as it undoubtedly will. Another is to employ dollar-cost averaging, which involves buying set dollar amounts of the stock at specific intervals, which results in a lower average cost.
Palantir Technologies won't appeal to every investor. However, for those willing to take on some additional risk for potentially explosive gains, Palantir sits at the crossroads of a vast opportunity that could make for a very profitable investment.
