Palantir May Be Turning the Corner, But Risks Remain

Palantir (NYSE:PLTR) stock was one of the more exciting names to go public last year. The company’s main focus – data analysis and security for governments – is an extremely hot category.

You’d think that a software company in this niche should own a digital gold mine. Yet, Palantir’s operating results up through 2020 were a huge mess, with Palantir losing hundreds of millions of dollars annually. That led to concerns about PLTR stock once it started trading a few months ago.

In 2020, however, Palantir’s quarterly earnings sharply improved. This raises the question of whether Palantir has finally figured out how to run its business more profitability, or whether it simply had a good year due to demand from the novel coronavirus.

With PLTR stock surging, investors are betting that Palantir has passed the inflection point. It’s worth thinking about the story a bit more before you get too bullish, however.

Historically Poor Operating Numbers

Up through Palantir’s recent initial public offering (IPO), the company had traditionally shown very poor operating metrics. For full-year 2018, for example, the company lost $623 million overall while bringing in just $595 million of revenues. Last year was barely better, as the company’s revenues improved modestly to $743 million, however, its operating loss was still at a chunky $576 million.

It’s one thing to run a small loss as a young software company, however, it’s another thing entirely to lose a dollar for every dollar of revenue you generate. That’s particularly true as Palantir has been in business since 2003. From 2015-onward, Palantir’s valuation was flat to down somewhat on the private market due to its massive operating losses.

However, in 2020, and in particular over the past quarter, PLTR stock has improved dramatically. In the most recent quarter, for example, Palantir essentially broke even once you back out costs related to the recent stock listing. Palantir even sees itself earning a small profit in Q4.

That’s sharply ahead of where the company had been in previous years. If the company can remain on its current trajectory, it may turn into a big winner after all. However, now investors must make sense of whether the current surge is more of a Covid-19 boost or a lasting trend.

Palantir’s Covid-19 Opportunity

One potential issue for Palantir is that it hasn’t yet reached critical mass with its software. While it can perform many novel and cutting-edge functions, up until now, it has seemingly struggled to convert that potential into a large enough actual customer base. Palantir’s customer base was surprisingly narrow, and its revenue growth was merely in the 20% range in recent years.

That’s not what’d you expect from a firm with Palantir’s abilities. However, it appears that the novel coronavirus is giving PLTR stock its chance to shine.

On Palantir’s third-quarter conference call, the company described the Covid-19 effect on its health care information business as follows:

“It may have started with Covid-19, but it’s not going to end there as the pandemic has revealed a broad swath of challenges and opportunities these institutions are rising to meet. And taken together with our commercial health care work, we believe these developments will have far-reaching positive implications for the future of health care, and we have the opportunity to be at the center of it.”

Palantir is winning all sorts of prestigious contracts now. For example, it scored a deal with the nation of Colombia’s government for contract tracing and preventing the spread of the virus. This is an ideal sort of use of Palantir’s big data capabilities. And, theoretically, Palantir can use this specific opening to help the health care industry as a whole involve more sophisticated data analysis in its workflows.

Health care is hardly the only opportunity for Palantir, either. The company has won major new contracts with branches of the U.S. military in recent months. It also appears set to earn more business going forward from exciting futuristic military operations such as the new Space Force.

PLTR Stock Verdict

The question at the end of the day is whether this serves as an inflection point for Palantir. Has the company finally found the road to profitability? Remember that the company has been in business almost 20 years now. Yet it has seen stubbornly large losses in recent times. Unlike so many software firms, Palantir has not been an overnight success.

Perhaps that will now change. Particularly if the company can harness its momentum with Covid-19 into a broader line of business, that could reset Palantir’s whole story.

Based on what we know today, however, PLTR stock is a future show-me story. It’s not one where the stock price is based on current fundamentals. Simply put, Palantir hasn’t generated enough revenue, and certainly not at good enough profit margins, to justify its current valuation. The company’s market cap is almost $50 billion for barely $1 billion a year of revenues. And there are doubts about how profitable the core business is.

In this sort of stock market, a hot software company like Palantir can trade above fair value for a considerable period of time. Unless Palantir can generate far stronger operating numbers in coming quarters, however, this stock rally is bound to reverse itself. Thus, it’s worth watching Palantir’s efforts in the health care space closely.

If management’s optimism about Covid expanding the marketplace is correct, that’d make a big difference. If the Covid-induced revenue growth was just a blip, though, PLTR stock would decline sharply in 2021.

On the date of publication, Ian Bezek did not have (either directly or indirectly) any positions in the securities mentioned in this article.

Ian Bezek has written more than 1,000 articles for InvestorPlace.com and Seeking Alpha. He also worked as a Junior Analyst for Kerrisdale Capital, a $300 million New York City-based hedge fund. You can reach him on Twitter at @irbezek.