Palantir’s Rise: A New Player in the Nasdaq-100

The Nasdaq Composite is a prominent U.S. stock index, focused on technology and digital companies. It tracks more than 3,000 stocks, while the Nasdaq-100 is a segment featuring about 100 of the largest non-financial companies on the exchange. To qualify for inclusion in the Nasdaq-100, companies must meet several criteria:

• Be exclusively listed on the Nasdaq exchange.
• Maintain high liquidity.
• Have been listed on an eligible exchange for at least three full calendar months.
• Ensure a minimum of 10% of outstanding shares are available for trading.
• Not have filed for bankruptcy.

The annual rebalancing for the index was announced on December 13, with Palantir Technologies (NASDAQ: PLTR) set to join the Nasdaq-100 effective before the market opens on December 23. Palantir’s stock has risen an astonishing 1,090% since early last year when generative artificial intelligence (AI) gained widespread attention. The company’s extensive experience with AI solutions likely contributed to its selection.

Despite the stock’s rapid ascent, some investors are hesitant to purchase it, worrying about its high valuation. However, one Wall Street analyst suggests that this viewpoint may be too narrow. Let’s dive into the factors driving Palantir’s stock increase and assess its future potential.

Image source: Getty Images.

Born from Crisis: Palantir’s Unique Beginnings

Palantir emerged after the events of 9/11, based on the belief that advanced AI algorithms could connect seemingly unrelated information to prevent terrorist threats. The company quickly gained strong support from U.S. intelligence agencies and allied nations, as military and law enforcement sectors adopted its solutions.

Over time, Palantir broadened its scope, offering data mining, analytics, and AI capabilities to enterprise clients. The recent AI boom attracted many new customers seeking innovative solutions. In response, Palantir developed the Artificial Intelligence Platform (AIP), which links AI with operational data to deliver timely, tailored solutions.

To address common knowledge gaps in businesses, Palantir established boot camps allowing clients to work closely with its engineers to create customized solutions. This strategy has shown success, as reflected in Palantir’s financial results and the increased willingness of businesses to embrace AI.

Strong Financial Growth

In the third quarter, Palantir reported a revenue of $726 million, marking a 30% annual growth and a 7% increase from the previous quarter. Earnings per share (EPS) also rose 100% to $0.06, making it the eighth quarter in a row of profitability. However, the numbers provide only part of the picture.

Particularly noteworthy is the growth in Palantir’s U.S. commercial segment, which includes a significant portion of its AIP revenue, increasing 54% year over year. This spike pushed the remaining deal value (similar to a backlog) up by 73%. The rising backlog suggests strong future prospects, evident as the segment’s customer base expanded by 77%.

Moreover, the government revenue segment, which has historically been foundational for Palantir, increased by 40% year over year and 15% sequentially.

The volume of new contracts signed also indicates positive momentum. In Q3, Palantir secured 104 contracts worth at least $1 million. Among these, 36 were valued at $5 million or more, and 16 were worth at least $10 million. Notably, many contracts followed participation in Palantir’s boot camps.

The demand for AI solutions from Palantir likely extends beyond current capabilities. According to McKinsey & Company, the generative AI sector could reach between $2.6 trillion and $4.4 trillion in the next decade, positioning Palantir favorably to benefit from these trends.

Investor Concerns: Is It Too Expensive?

Despite bright prospects for Palantir, some investors worry the stock may be overvalued. Among 20 analysts who rated the company in December, only four deemed it a buy or strong buy, while nine recommended holding, and seven suggested selling. Most bearish analysts attribute their stance to the company’s high valuation.

Current metrics suggest cautiousness; the stock trades at 380 times earnings and 69 times sales, considered extremely high. However, traditional metrics may be misleading when assessing high-growth firms. For instance, Palantir’s forward price/earnings-to-growth (PEG) ratio is 0.63, indicating it may be undervalued as a future growth opportunity.

Dan Ives, a seasoned tech analyst at Wedbush, maintains a positive outlook, keeping an outperform (buy) rating for Palantir with a price target of $75, which the stock has recently surpassed. He expressed confidence in Palantir’s AIP strategy, predicting “unprecedented demand” over the next 12-18 months as more businesses adopt AI solutions.

While Palantir’s market cap sits around $172 billion, Ives suggests it could rival Oracle in growth, which has a market cap of $494 billion. This implies potential upside of 188% for Palantir, though reaching that vision may take time.

Investors facing the valuation dilemma might consider starting with a small position in the stock, allowing for future adjustments if the price drops. Another strategy is dollar-cost averaging, which helps lower the average purchase cost over time.

Palantir Technologies may not attract every investor, but for those open to taking calculated risks for significant potential returns, it represents an intriguing opportunity.

A New Investment Opportunity Awaits

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*Stock Advisor returns as of December 9, 2024

Danny Vena holds positions in Palantir Technologies. The Motley Fool has positions in and recommends Oracle and Palantir Technologies. The Motley Fool has a disclosure policy.

The views and opinions expressed herein are those of the author and do not necessarily reflect those of Nasdaq, Inc.