Three Reasons Why Palantir's Artificial Intelligence (AI) Shares Are Outstanding Buys at present (Spectacular Income and Profit Expansion, Not Just Good Figures)

Three Reasons Why Palantir's Artificial Intelligence (AI) Shares Are Outstanding Buys at present (Spectacular Income and Profit Expansion, Not Just Good Figures)

Last Tuesday, Palantir Technology Inc. (PLTR), saw a staggering 23.5% surge in its stock price, following the release of its impressive third-quarter 2024 report on Monday.

The boom was fueled by the report's revenue and earnings exceeding Wall Street's predictions, an uptick in fourth-quarter revenue expectations, and a bump in its full-year 2024 guidance for various key metrics.

The quarter showed a 30% and 43% increase in year-over-year revenue and adjusted earnings per share (EPS), respectively. CEO Alex Karp attributed this growth to relentless demand for artificial intelligence (AI). Both the government and commercial sectors performed admirably, with their revenues rising by 33% and 27%, respectively. The revenue breakdown for the government and commercial sectors was 56% and 44%, respectively.

Palantir's robust revenue and profit growth aren't its only strengths. Here are three additional reasons why Palantir's stock is one of the best in the AI market:

1. It has a business model that generates recurring revenue

As a SaaS company, Palantir distributes its software through cloud subscriptions. Its core business model relies on recurring revenue. SaaS businesses that generate recurring revenue are typically attractive due to their high profit margins and predictable revenue streams.

Palantir's business strategy is performing well. In Q3, its net-dollar retention rate rose to 118%, up from 114% in the previous quarter, according to CFO Dave Glazer's comments on the earnings call. This indicates that its current customers from the previous year increased their spending on its products by an average of 18% over the past year. It's important to note that this figure does not include new customers acquired during that period, so it does not fully capture the speed at which its U.S. business has accelerated in the past year.

2. Its free cash flow (FCF) margin is on an upward trend and was impressive in the quarter

Free cash flow margin is derived by dividing free cash flow by revenue. This metric demonstrates the percentage of a company's revenue in a given period (such as quarterly or annually) that it transformed into free cash flow.

Palantir reported an FCF margin of more than 57% in Q3, a remarkable figure. (The company uses a slightly different metric for FCF called adjusted FCF. Its adjusted FCF margin was 60% in the quarter, with both figures highlighting the point.)

For comparison, we looked at other companies with stellar track records of delivering strong FCF margins: Nvidia (NVDA), Meta Platforms, Microsoft, and Broadcom.

Although quarterly cash flows can fluctuate, a more telling metric is FCF margin over an annual period. However, except for Microsoft (whose fiscal year concluded on June 30, as indicated by the orange line), the most recent annual FCF margin figures for the other companies may be somewhat outdated.

3. Minimal to no sales to China

Unlike many other AI-related companies, such as Nvidia and other chipmakers as well as chip equipment manufacturers, Palantir either generates minimal or no revenue from China. According to its Q3 filing with the Securities and Exchange Commission (SEC), Palantir has no interest in pursuing business opportunities with the Chinese Communist Party, does not host its platforms in China, and imposes restrictions on access to its platforms in China.

This is crucial because it ensures that Palantir's business will not be significantly affected if the U.S. government tightens export restrictions on AI-enabling products to China and other select countries that surpass certain performance thresholds.

Palantir's stock valuation is high, but it's worth the investment

Palantir stock is trading at 127 times its projected 2025 earnings. While this is a high forward P/E ratio, it is not unreasonably so for a company that analysts anticipate will grow earnings by 48% this year and at an average of 58.8% over the next five years, and whose free cash flows consistently and significantly surpass net income.

When investing in stocks, it's best to average your cost over time (dollar-cost averaging). Using this strategy to purchase shares of Palantir is particularly important for stocks that have recently experienced significant price increases, as they may soon experience a correction due to profit-taking.

For instance, if you wanted to invest $1,000 in Palantir stock, you could purchase $250 worth of shares every quarter for a year. Alternatively, you could make smaller purchases monthly or longer. This way, you avoid buying all your shares at what might turn out to be a short- or long-term peak.

After analyzing Palantir's impressive financial performance, investors are considering where to allocate their money in the finance and investing landscape. Given Palantir's high forward P/E ratio and projected annual earnings growth, some might question whether it's a worthwhile investment. However, considering its strong business model generating recurring revenue, impressive free cash flow margin, and minimal exposure to China, Palantir could be an attractive option for those seeking long-term growth in the money market.

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