Palantir: Yes, It's Ridiculous

Summary

• Palantir Technologies Inc.'s underperformance in 2022 is not just due to a general decline in the major benchmark indices, but more generally due to overly high expectations and an unreasonably high valuation.
• Currently, one piece of positive news follows the next - but that is no guarantee of sales growth shortly. That was also the case in the past quarters.
• The EPS expectations seem ridiculously positive to me - given the projected slowdown in revenue growth, analysts foresee Palantir Technologies' EPS numbers will grow in a strictly straight line through 2024.
• The situation is not good for Palantir in terms of risk-reward profile - at least if you follow my SOTP valuation model.
• I do not recommend buying Palantir at current levels.
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Andreas Rentz/Getty Images Entertainment

Intro & Thesis

It is now mid-December, which means it is time to update my thesis regarding Palantir Technologies Inc. (NYSE:PLTR) stock, as all my previous calls regarding this company aged well in one form or another:

TipRanks [as of December 12]

In this article, I reiterate my bearish thesis that PLTR remains an overvalued company whose valuation is based only on high future expectations and strong sales growth, which meanwhile, has slowed recently. This has led PLTR to perform relatively weak even compared to the NASDAQ Composite Index (COMP.IND) - chances are this underperformance will continue for a while until we see real improvements. I do not recommend buying PLTR, even after its 61% decline YTD.

Why do I think so?

First off, let me start with some good news for PLTR - the company continues to sign new commercial contracts at a relatively astronomical pace, adding names like Beckett Collectibles, Hertz, and Crisis24 to its customer base in recent months. Not to mention other positive news for the company, such as the expansion of modernization work with the FDA or the renewed partnership with the CDC.

Having been watching PLTR for a long time (since Oct 5, 2021), I know that such news pieces, even if they sound positive ("new contracts = new revenue stream"), in reality, do not always speak of an acceleration of the company's growth. In terms of IR/PR, Palantir is doing its job very well - in fact, the company spends over 38% of its sales on sales and marketing expenses (as of September 30, 2022), which is 2.5% higher than the previous quarter and above the median of other SaaS (Software as a Service) companies:

Author's work, based on YCharts

News after news comes out, and bullish investors, even those who bought the stock above $20, continue to feed their confirmation biases and confidently hold the stock in a long-term portfolio, hoping for the best somewhere in the future (preferably not too far away).

I decided to see how the number of positive news about new contracts and partnership agreements correlates with the actual growth of the company's revenues.

Author's calculations, Seeking Alpha data

Q4 2022 is not over yet, and the amount of positive news (those about new contracts and partnerships) has already reached the amount we saw in Q1 and Q2 2022, when PLTR grew by 48.8% and 49.13% y-o-y, respectively.

Every new contract or partnership the company signs lead to long-term revenue and creates a backlog of orders - meaning that positive news does not usually show up immediately on the company's income statement. Therefore, as you may have noticed, the amount of such positive news in a quarter does not correlate strongly with what kind of growth the company then reports. However, PLTR has developed a relatively high revenue base over the years that has resulted in stagnant growth despite the overall backlog - which is why, despite all the positive news, analysts see revenue growth continuing to stagnate in Q4 2022.

Even though the Q4 2022 revenue growth forecast is almost 2 times lower than the long-term CAGR (about 30%) that Alex Karp (the CEO) has talked about many times, retail investors looking at the plethora of good news around the company continue to believe in his words - as evidenced by SocialSentiment.io's rating:

SocialSentiment.io, author's notes

For comparison, here you can see the retail sentiment on Microsoft (MSFT) stock, which has fallen by only 26.7% since the beginning of the year:

SocialSentiment.io, MSFT

From this, I conclude that retail investors, who were optimistic about PLTR at the beginning (the IPO or a bit later), still are bullish because of all the "good news", although the sales forecasts over the past 3 months have been revised downwards by the Street in 7 out of 8 cases.

But at the same time, analysts have raised their EPS forecasts 8 out of 9 times (in the same period), claiming that the company will increase its EPS by 270% in FY2023 (from 5 cents to 17 cents per share):

Seeking Alpha date, PLTR, Earnings Estimates

This is what strikes me as ridiculous - with such a slowdown in revenue growth as we are currently seeing based on analysts' forecasts, they believe EPS will grow in a strictly straight line - and at a time of rising rates and generally deteriorating business development conditions. To understand why such a forecast is off, you only need to look at the past - it is not a guide to the future, but it does allow us to assess how the company had the opportunity to grow in the same way against a backdrop of much milder macro conditions, but for some reason did not.

Author's calculations, based on Seeking Alpha

I do not see any good reason why this should change overnight starting next quarter. On a GAAP accounting basis, PLTR is still a deeply unprofitable company with an EBIT margin of -13% (vs. -8.8% last quarter) and EPS of -$0.06 (vs. -$0.05 in Q3 2021). I do not see any scenario where the company can catch up so quickly in such a short time (only 2 years).

The valuation still does not give a good risk-reward profile

If you read my latest article on Palantir, you probably remember how I calculated the "relatively fair" value per share - if you are not familiar with my SOTP model, I recommend you familiarize yourself with it at this link.

In short, I updated the Sum-Of-The-Parts valuation model, which was based on comparing price-to-sales multiples of various Palantir's peers (in both of its business segments) with projected revenue growth rates for the next year (FY2023). By expressing the company multiples in terms of projected growth rates, we get a rough idea of how much the revenue-based valuation depends on what percentage of revenue growth is priced in by the Street.

Last time, we got a model result suggesting Palantir was "relatively fairly" valued - its forwarding price-to-earnings ratio was roughly in line with what analysts at WS thought its revenue growth would be in 2023. Now, however, we see how the situation has deteriorated slightly for the company, even though PLTR has fallen about 7% since that thesis was published (now PLTR is trading at a premium of about the same amount):

Government =		42.68%
Company name	P/S (FWD)	Sales growth FY2023, YoY
Booz Allen Hamilton (BAH)	1.516	9.33%
Science Applications International Corp. (SAIC)	0.795	2.69%
Leidos Holdings (LDOS)	1.021	5.05%
CACI International (CACI)	1.069	6.53%
L3Harris Technologies (LHX)	2.451	3.90%
HEICO Corporation (HEI)	8.518	14.30%
Curtiss-Wright Corporation (CW)	2.549	5.51%
Average	2.560	6.76%
Commercial =		57.32%
Company name	P/S (FWD)	Sales growth FY2023, YoY
Tyler Technologies (TYL)	7.259	8.00%
Verint Systems Inc. (VRNT)	2.694	2.44%
Splunk Inc. (SPLK)	4.129	29.82%
Cognizant Technology Solutions Corp. (CTSH)	1.55	4.12%
Alteryx (AYX)	3.815	16.76%
Snowflake (SNOW)	22.64	68.37%
Average	7.01	21.59%
Gov's P/S per 1% sales growth	37.88
Com's P/S per 1% sales growth	32.50
Palantir's Gov growth, FY2023, YoY	18.33%
Palantir's Com growth, FY2023, YoY	23.30%
implied PLTR's FWD P/S	7.30
vs. current P/S (FWD)	-6.05%

Click to enlarge

Source: Author's calculations

Author's work, sensitivity table analysis

If the company's growth is 2% higher in 2 business segments at once (Government and Commercial), then PLTR is undervalued by about 11.8%. However, if the actual sales growth is 2% lower (also for 2 segments at once), then the overvaluation will be more than twice higher - about 24%. So the situation is not good for PLTR in terms of risk-reward profile - at least if my SOTP valuation model makes sense to you.

Bottom Line

Once again, I have to conclude that PLTR's underperformance in 2022 is not just due to a general decline in the major benchmark indices, but more generally due to overly high expectations and an unreasonably high valuation. As was the case a year ago, we are now dealing with roughly the same conditions for the continuation of this very poor performance - analysts are still expecting huge growth from PLTR (quarterly EPS CAGR of 21.5% over the next 9 quarters), which is not clear how it will be realized against the backdrop of stagnant revenue growth (quarterly CAGR of just 4.9% over the same period).

In turn, the company's valuation has only worsened based on my SOTP model, although the stock has only accelerated its slide since the last update of this model, losing another 7% in value.

My conclusions are, of course, fraught with risk - retail investors are far from the only buyers of PLTR drawdowns, as they are supported by Stanley Druckenmiller and maybe other big believers. I have already explained why you should not follow these purchases, but I could be wrong and the RSI divergence that is showing on the daily chart right now will lead to an explosive rise in prices.

TrendSpider, PLTR, author's notes

However, I would not buy PLTR on technical analysis grounds alone, as the risk of further downward repricing of expectations or negative EPS/sales surprises against the backdrop of a P/S ratio of >7.7x further fuels my bearish sentiment.

I do not recommend buying PLTR at current levels.

Thanks for reading!

Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.