A popular technology stock with enormous potential

Rallying almost 400% over the past 17 months, this American tech firm is one of the best performing US stocks. Analyst Rodney Hobson explains what he’d do with them now.

2nd October 2024 08:27

Rodney Hobson from interactive investor

One of the big leaders in the upward surge of American tech stocks has been Palantir Technologies Inc Ordinary Shares - Class A (NYSE:PLTR), which has been a great favourite among interactive investor customers. The valuation has, however, now got quite silly and it is surely time to consider taking profits. If the shares run out of steam, the downside could be rather severe.

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It is worth rereading Edmond Jackson’s excellent analysis, published in April, of Palantir’s partnership with Oracle Corp (NYSE:ORCL) to provide secure cloud and artificial intelligence (AI) solutions to businesses and governments around the world.

Palantir’s shares at that stage stood around $22 and Edmond rightly identified potential upside. They are now just below $37, having reached prices not seen since February 2021. Yet results have not justified a valuation of more than 200 times earnings.

The problem is that although Palantir has enormous potential it has been lossmaking for most of the time since it was set up in 2003. There is no dividend and no hope of one for several years as developing products – an expensive aspect of tech stocks – soak up any cash generated in a competitive sector. There are enough producers of clouds and artificial intelligence snapping at the heels of the pacemakers to force tech companies to push constantly for the next big breakthrough.

It does seem highly likely that annual revenue will take off rapidly from the current level of $2.2 billion, as Palantir’s products will be in increasing demand from both the public and private sectors where the company operates to equal effect.

Palantir started as a supplier of big data analytics software to the Department of Defense and intelligence agencies in the United States, expanding to winning contracts with other governments including the UK. A series of potentially lucrative new contracts with the US government have been signed over the summer.

Commercial sales have just about caught up and continue to grow faster. The group is also expanding its customer numbers, so it is becoming increasingly sheltered from a turndown at any one company that it supplies. New customers tend to spend more with each passing year.

Total sales are projected to grow a very impressive 24% this year. However, that projection compares with growth of 40% when the shares were last on a fantastic valuation and there is likely to be a further slowdown, with 20% last year. While many companies would be delighted with 20% sales growth, not many are on hard-to-justify valuations.

More important than revenue growth is profitability. This is hard to judge as Palantir has only recently swung into profit, although now at least has a positive operating margin, albeit only 12%, which is much lower than for other software providers but massively better than the minus 40% reported only two years ago. Some better indication will come with the next quarterly figures due in early November, but it is fair to assume that there will be profits from now on.

As for the share price, investors should remember that what goes up can come down just as quickly. The last peak was followed by a collapse to only $6 in just under two years.

Source: interactive investor. Past performance is not a guide to future performance.

Hobson’s choice: I have advised taking profits in Palantir twice before. The first time was spectacularly right at above $20 before the shares lost 70% of their value. However, I was premature to issue the same advice after the recovery reached $15. At current levels the risks outweigh the potential rewards. Even on an optimistic forward rating the shares sell at 100 times potential earnings, double the ratings for more reliable investments such as Microsoft Corp (NASDAQ:MSFT) and Amazon.com Inc (NASDAQ:AMZN). Sell.

Rodney Hobson is a freelance contributor and not a direct employee of interactive investor.

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