3 Reasons Why Palantir Stock Is One of the Best Artificial Intelligence (AI) Stocks to Buy Now (Besides Big Revenue and Earnings Growth)

Last Tuesday, Palantir Technologies (PLTR 3.17%) Shares skyrocketed 23.5% following the software-as-a-service (SaaS) company’s launch the previous afternoon. strong third quarter 2024 report.

The stock’s rise was driven by quarterly revenue and earnings surging ahead of Wall Street’s forecasts, fourth-quarter revenue forecast coming in higher than the Street expected, and management raising its full-year 2024 forecast for revenue and several other key metrics.

CEO Alex Karp said the quarter’s year-over-year revenue and adjusted earnings per share (EPS) rose 30% and 43%, respectively, driven by “relentless” artificial intelligence (AI) demand. Both government and commercial businesses performed well, with revenues up 33% and 27% respectively. Government/commercial revenue split was 56%/44%.

In addition to strong revenue and profit growth, here are three other key reasons why Palantir shares are one of the best AI stocks on the market.

1. It has a business model that produces constant income

Palantir is a software as a service (SaaS) company. It provides its software via the cloud through subscriptions of varying lengths. Thus, the main business generates constant income.

SaaS businesses that generate recurring revenue tend to be attractive. They generally have high profit margins and their revenue streams tend to be more predictable.

Palantir’s business model works well. CFO Dave Glazer said net dollar retention in the third quarter increased to 118% from 114% in the previous quarter. earnings call. This means that existing customers in the prior-year quarter increased their spending on their products by an average of 18% compared to last year. As Glazer noted, this metric doesn’t include revenue from new customers acquired last year, so it “hasn’t quite caught up to the momentum in our U.S. business from last year yet.”

2. Free cash flow (FCF) margin is on an upward trend and has performed exceptionally well this quarter

Free cash flow margin is calculated by dividing FCF by revenue. This metric tells us what percentage of a company’s revenue over a given period (such as quarterly or annual) turns into free cash flow.

Data from YCharts.

Palantir’s FCF margin was just over 57% in the third quarter, which is outstanding. (The company uses a slightly different measure for FCF, called adjusted FCF. Adjusted FCF margin was 60% in the quarter. It doesn’t matter, because 57% and 60% are close and both make that point.)

For comparison purposes, Nvidia (NVDA -1.60%), Meta Platforms, MicrosoftAnd broadcom These companies were used because they have an excellent track record of delivering strong FCF margins. In other words, the comparison bar here is high.

Granted, quarterly cash flows will vary, so a more meaningful metric is the FCF margin for the annual period. But aside from Microsoft (whose fiscal year ended on June 30, as the orange line shows), for other companies this metric from the most recent fiscal year is a bit outdated.

3. Limited to no sales to China

Unlike many other companies in the AI ​​space such as Nvidia and others chip manufacturers Palantir, as well as chip equipment manufacturers, generates limited or no revenue from China. Here’s what he said about it in a third-quarter filing with the Securities and Exchange Commission (SEC):

We do not pursue any sales opportunities with the Chinese communist party, we do not host our platforms in China, and we impose restrictions on access to our platforms in China (…).

Why is this important? That’s important because investors can be confident that Palantir’s business won’t take a significant hit if the U.S. government further tightens restrictions on exports to China and other AI-enabled products that exceed certain performance thresholds.

Palantir shares are overvalued, but it’s worth paying the price

I reiterate part of the closing portion of my Palantir Q3 earnings article with updated relevant numbers:

Palantir shares are trading at 127 times forecast (2025) earnings. This is a very high forward price/earnings (P/E) ratio. But that’s not too high for shares of a company that Wall Street predicts will grow its earnings by 48% this year and grow at an average annual rate of 58.8% over the next five years. And This creates strong free cash flows (FCFs). FCF consistently and significantly exceeds net income.

When you decide to buy a stock, it’s best to use dollar cost averaging (DCA) to arrive at your exact position. Using this method to buy stocks is even more important for stocks that have recently gone up and may pull back soon due to profits.

As an example, if you wanted to set aside approximately $1,000 to purchase Palantir shares, you could purchase $250 worth of shares every three months for a year. You can also make smaller monthly purchases for a year or more. This way, you don’t run the risk of buying all your shares at a time that may turn out to be a peak in the short or long term.