Nvidia(NASDAQ: NVDA) is a great artificial intelligence (AI) company and its stock is worth buying for many reasons. These include that it dominates the fast-growing AI chip market and that CEO Jensen Huang has an excellent track record of staying ahead of the competition.
That said, Nvidia’s sheer size will make achieving strong percentage growth in key metrics – such as revenue, profit, cash flow – increasingly challenging as time goes on. All other things being equal, it is easier for smaller companies to grow percentage-wise.
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Palantir Technologies(NYSE:PLTR) is an AI company that is much smaller than Nvidia and growing rapidly. Assuming management continues to perform well, the stock has the potential to be a big winner in the long term, just like Nvidia stock has been. A major reason for this potential is the company’s fantastic business model.
Palantir is a software-as-a-service (SaaS) company that delivers AI-powered software via the cloud through subscriptions. Its clients include agencies within the U.S. government and those of our allies, as well as commercial clients across a wide range of industries. The platforms help customers use their data to increase efficiency and effectiveness.
Palantir originally targeted US government agencies involved in intelligence and defense. The heavy reliance on government spending – which can be very bumpy – made some investors hesitant to buy shares early on. But the company is making great progress in building its commercial business. In the just-reported third quarter, Palantir’s government operations accounted for 56% of total revenue, while its commercial operations brought in the remaining 44%.
Metric/characteristic
Palantir
Year established
2003
How long publicly traded?
4+ years (since September 2020)
Led by a founder?
Yes
Market capitalization
$137 billion
Profitable in the most recent quarter on a GAAP* basis?
Yes
Profitable over the subsequent 12-month period on a GAAP* basis?
Data source: Yahoo Finance. Data as of November 11, 2024. GAAP = generally accepted accounting principles.
Palantir has not been publicly traded for very long, but it is well established. Plus, unlike many tech companies that are relatively new to the public, it’s profitable.
For reference, Nvidia has a market cap of almost $3.6 trillion as of November 11. That makes its market cap about 26 times larger than Palantir’s.
Palantir has a business model that generates recurring revenue. Companies with such business models tend to be attractive for a number of reasons:
They can yield very high business and profit margins.
They can generate strong operating cash flow margins (operating cash flow/sales) and free cash flow margins (free cash flow/sales).
Their income streams tend to be more stable.
They typically have relatively low capital expenditures. In the case of SaaS companies, they don’t sell a physical product, which means they don’t have to invest in factories.
As long as Palantir keeps its existing customers happy, it should expect most of them to renew their subscriptions and some of them to increase their spending on subscriptions. This is a huge positive point, because it is often time-consuming and expensive for companies to acquire new customers.
Palantir indeed pleases its existing customers. In the third quarter, the net dollar retention rate was 118%, CFO Dave Glazer said during the company’s third-quarter earnings call. This means that its existing customers from the previous year quarter have increased their spend on its products by an average of 18% over the past year. But Palantir also grows by adding new customers.
Data sources: company earnings reports. MRQ = most recent quarter. Operating margin = income from operations/sales; profit margin = net income/sales; cash flow margins were previously defined.
I chose Microsoft as my comparison company because it is software-oriented and known for its high profit margins and strong cash flows. In other words, it’s a tough comparison – and look how well Palantir is doing.
One number may jump out at you: Microsoft’s free cash flow margin. The reason this is much lower than the company’s operating cash flow margin is because Microsoft has high capital expenditures. It needs to invest in data centers to keep its cloud computing services business competitive.
If you’re a long-term investor, the first thing you should do when considering buying a stock is read up on a company’s business model. You can learn a lot about the business model just by looking at how it makes its money. Of course, there are other factors to consider, such as what are the advantages over potential competitors? Who is the target group? How potentially large is the target group?
Companies with sub-par or just good business models can do well in the short term, and their stocks can even soar in the short term. But these companies’ stocks won’t be big winners in the long term.
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*Stock Advisor returns November 11, 2024
Beth McKenna has positions at Nvidia. The Motley Fool holds positions in and recommends Microsoft, Nvidia, and Palantir Technologies. The Motley Fool recommends the following options: long January 2026 $395 calls to Microsoft and short January 2026 $405 calls to Microsoft. The Motley Fool has a disclosure policy.
1 Key Reason Why Palantir Stock Has the Potential to Become the “Next Nvidia Stock” was originally published by The Motley Fool
