2 Reasons to Buy Palantir, and 1 Reason to Sell

Key Points

• Palantir stock has soared 1,900% in recent years.

• Customers are flocking to Palantir for its artificial intelligence (AI)-driver software platform, and that’s kept earnings climbing.

• 10 stocks we like better than Palantir Technologies ›

Palantir Technologies (NASDAQ: PLTR) has been around for more than 20 years, and over this time, it's progressively built out a massive software platform -- and a booming business serving the U.S. government.

But in recent years, this once under-the-radar company exploded into the spotlight. This is greatly due to Palantir's adoption of artificial intelligence (AI) to supercharge its software offerings. The company launched its Artificial Intelligence Platform (AIP) two years ago, and both government and commercial customers have rushed to get in on it.

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All this has helped Palantir's earnings to soar, and the stock price has followed. In fact, over the past three years, Palantir shares have climbed a jaw-dropping 1,900%.

Many investors are wondering whether they should invest in this AI company -- or if it's too late. Before making any decisions, let's check out two reasons to buy, and one reason to sell.

Image source: Getty Images.

Reason to buy: Commercial sales are skyrocketing

In its early days, Palantir was most associated with government contracts, and commercial business wasn't much of a growth driver. But in recent times, the picture has changed. Commercial business has been roaring higher quarter after quarter as companies and organizations sign up for AIP.

The platform helps these customers access their disparate data and use all of this information to make key decisions, streamline operations, and make discoveries. In the latest earnings call, Palantir said AIP is driving the expansion of current U.S. commercial deals and the acquisition of new ones. Total U.S. commercial contract value, climbing 222%, reached a record $843 million.

Today, Palantir has 485 U.S. commercial customers, up from 14 just a few years ago. That's tremendous growth, but the number of customers now still leaves room for much more growth down the road, especially considering the need for AI may be in its early days. Analysts forecast a trillion-dollar market by the end of the decade.

So commercial sales could continue powering Palantir's revenue higher for years to come, and that's as government revenue continues to climb in the double digits.

Reason to buy: Palantir's Rule of 40

When investors speak of Palantir, they often focus on the company's growth. But what's truly impressive is Palantir's ability to balance growth with profitability. This is measured in the software industry by the Rule of 40. It's calculated by adding the company's revenue growth rate and profit margin. If the result is 40%, the company is considered to be doing a good job of balancing revenue growth and profit.

In recent quarters, Palantir's Rule of 40 has been greatly surpassing 40%, showing the company truly is winning in this area. In the latest quarter, Palantir's Rule of 40 totaled 94% -- that's up from 83% in the previous quarter.

Even more impressive, software companies don't always find it easy to attain the Rule of 40, so Palantir's performance stands out. Just under one-third of companies reach the Rule of 40, and far fewer maintain it, according to McKinsey & Co. research.

Reason to sell: Palantir's steep valuation

Gains over the past few years have pushed Palantir's valuation higher and higher, and today the stock trades for 241x forward earnings estimates. That's incredibly steep, even for a growth company.

PLTR PE Ratio (Forward) data by YCharts

So, if you buy the stock now, you may feel as if you've paid too much for it. And if you already own the stock, you may worry that this high valuation will limit further gains -- the idea is investors may no longer rush to get in on it at these levels, and as a result, it will either stagnate or decline.

For this reason, you might consider selling Palantir today and locking in profits.

What's the right decision?

Let's start with the sell argument. Yes, Palantir is expensive today, but it's important to remember that the price-to-earnings ratio uses earnings expectations from the year to come -- it doesn't take into account earnings potential farther down the road. This means if you buy now and hold on for a number of years, you still could see significant gains.

So, if you aim to buy a stock and sell it in a period of a few weeks or even months, Palantir may be risky. But if you're a long-term investor -- aiming to hold on for at least five years -- the valuation issue may not interfere with your potential to win.

And that means right now, considering the two reasons to buy that I mentioned, Palantir makes a great addition to a long-term growth portfolio.

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Adria Cimino has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Palantir Technologies. The Motley Fool has a disclosure policy.