Here’s what can happen next

It finally happened. After shares rose more than 250% in value this year, Palantir (NYSE:PLTR) has now surpassed the legendary defense contractor Lockheed Martin in terms of market capitalization. The provider of software and artificial intelligence (AI) for the government, military and big business is posting strong revenue growth and an inflection in earnings. It just reported third-quarter results, sending the stock up 40% in the past month.

Investors are becoming increasingly bullish on Palantir stock. But should they be? Here’s what could happen next for this hypergrowth momentum stock.

One of the largest defense contractors in the world

With a market capitalization of $136 billion, Palantir is now one of the largest defense contractors in the world. The aforementioned Lockheed Martin has a market cap of $134 billion, with competitors like RTX companynow one of the few stocks with higher valuations than Palantir.

How did it get here? With modern software solutions for the US military and government agencies. This disrupted legacy systems (or where systems didn’t exist at all), as the US government looks for the best software to stay ahead. Government contracts are large and can expand over time. Therefore, Palantir’s US government revenues continue to grow at a rapid pace. Last quarter, US government revenues grew 40% year over year.

But Palantir doesn’t just sell to the US government. In recent years, the company has expanded to bring its software and AI solutions to large enterprises with great success. Although the US government can spend a lot of money, at the end of the day it is only one customer. Hundreds of companies could use Palantir’s advanced analytics tools, and they are starting to do so.

Fast revenue growth, faster customer acquisition

Increasing demand from the US government and US companies has enabled Palantir to accelerate its revenue growth. Last quarter, U.S. commercial revenues grew 54% year-over-year to $179 million. With the addition of steady government contract growth and a slight headwind from international sales, total third quarter revenue grew 30% year over year to $726 million.

Customer acquisition is growing even faster. Total customers grew 39% year over year in the third quarter and 6% from the second quarter to 629. That may seem like a small number, but remember: Palantir focuses only on the largest companies operating in are looking for custom software. The acceleration after Q3 seems to continue. Palantir closed 104 deals worth more than $1 million in the quarter, which should bring in new revenue-generating customers in the coming years. Given the long-term nature of these contracts, the number of customers is the most important performance measure for investors to track. If customer numbers continue to rise, sales growth will follow.

PLTR Earnings Data (TTM) according to YCharts

What’s next for Palantir stock?

We’ve talked a lot about Palantir’s business. The stock is another matter. Growth and value are linked (as Warren Buffett likes to say), meaning it doesn’t just matter whether a company is growing revenue quickly. It also matters what price you pay for that growth.

The good news for Palantir is that even as growth accelerates, profit margins have remained strong. Generally accepted accounting principles (GAAP) net income last quarter was $144 million, with a margin of 20%. Once revenue growth slows, I expect profit margins to increase to 30% or higher due to the low variable costs of running a software company.

Over the past twelve months, Palantir has generated $2.65 billion in revenue. Let’s be optimistic and assume that revenue growth will remain strong over the next five years, and that this figure could reach $10 billion. Optimistic for sure, but not ruled out. With a 30% net margin, that equates to $3 billion in annual revenue.

Today, Palantir has a market cap of $136 billion. Even if these earnings figures are met, the stock will trade at a price-to-earnings (P/E) ratio of 45 in five years. That would be a steep valuation, and it’s five years after the monster growth estimates and margin expansion. The price you pay for a share matters. While Palantir is a great company, I think the stock will perform poorly over the next five years.

Should You Invest $1,000 in Palantir Technologies Now?

Consider the following before purchasing shares in Palantir Technologies:

The Motley Fool stock advisor The analyst team has just identified what they think is the 10 best stocks for investors to buy now… and Palantir Technologies wasn’t one of them. The ten stocks that survived the cut could deliver monster returns in the coming years.

Think about when Nvidia made this list on April 15, 2005… if you had $1,000 invested at the time of our recommendation, you would have $870,068!*

Stock Advisor provides investors with an easy-to-follow blueprint for success, including portfolio building guidance, regular analyst updates, and two new stock picks per month. The Stock Advisor is on duty more than quadrupled the return of the S&P 500 since 2002*.

View the 10 stocks »

*Stock Advisor returns November 11, 2024

Brett Schafer has no position in any of the stocks mentioned. The Motley Fool holds positions in and recommends Palantir Technologies. The Motley Fool recommends Lockheed Martin and RTX. The Motley Fool has a disclosure policy.