Palantir: Time To Double Down

After gaining momentum and later declining in price in the last couple of months due to the AI-related rally, Palantir's (NYSE:PLTR) stock is once again on a winning streak as it reached new 52-week highs just last week and currently trades close to those levels. In early August, the company is expected to report its Q2 earnings results, which would give investors a better understanding of whether this AI-related premium at which its shares currently trade is justified in the first place. Even though Palantir appears to be greatly overvalued right now, there are reasons to believe that the company's growth story is far from over and there's still some upside left.

Is Generative AI The Next Big Thing?

Last month I published an extensive article on Palantir's work in Ukraine, explained how the company is able to test its software on an actual battlefield in real-time and also addressed some of the bearish points that were raised by a popular short-selling newsletter. While that article extensively covered various parts of Palantir's business, it didn't fully highlight how the company now has the potential to aggressively grow its sales and greatly improve its performance thanks to its entrance into the generative AI field a couple of months ago. Considering that Palantir's stock has been able to skyrocket in the last few weeks and reach its 52-week highs mostly thanks to the market's obsession with AI, I decided to share some of my thoughts on why shares have the potential to appreciate even further ahead of the release of Q2 earnings results in August.

In the last few months, I have been incorporating various generative AI applications into my workflow, which were able to perform a range of mundane tasks and helped me to increase my productivity. By having a first-hand experience with generative AI, I concluded that it's not another fad like the metaverse and it actually has the potential to have a profound impact on our society. That's likely one of the main reasons why we begin to see reports which expect the generative AI field to become an over $1 trillion market in the next decade and grow at a CAGR of over 40%. Add to all of this the fact that Apple (AAPL), Meta Platforms (META), Amazon (AMZN), and even Elon Musk revealed their own generative AI products in the last few weeks and it becomes obvious that it's not another hype story. As Big Tech scales its presence in the field, so is Palantir with the introduction of AIP in April.

From what we know so far, AIP promotes human-AI collaborations by helping organizations deploy large language models within their internal systems that could understand, recommend, and trigger different business processes and actions. Think of it as ChatGPT that's personalized for your own workflow and is working within your environment whether you're a commercial or a military client of Palantir. In May, the company's management revealed that they are seeing unprecedented demand for AIP while earlier this month Bloomberg reported that the US military has also started testing generative AI applications and also noted that Palantir is one of the companies that develops AI-based platforms for the Pentagon.

Considering this, there are reasons to believe that Palantir's stock still has more upside after the latest rally, but only the Q2 results and an updated outlook for the year will properly show how much of this unprecedented demand will translate into monetary value.

What's Next?

We already see how other companies that became leaders of the generative AI field earlier this year have seen their estimates for the year greatly increase. Some analysts now believe that Microsoft (MSFT) would be able to generate an additional $20 billion in revenues thanks to the launch of a single generative AI feature for its core products, while others think that the company would even be able to double revenues for some of its flagship products in the following years. The street now also expects Nvidia (NVDA), which sells major GPUs on which generative AI applications run, to increase its EPS by ~138% Y/Y and grow its revenues by ~61% this fiscal year.

Despite this, most analysts still have no idea how big of an impact the AIP sales would have on Palantir's overall performance. To this day, the street expects the company's revenues to increase only by 15.9% Y/Y in FY23, which is in-line with the previous estimates before the generative AI applications truly took off and increased in popularity. Therefore, it seems that analysts expect further guidance from the management before deciding whether to revise their forecasts.

However, if Goldman Sachs (GS) is correct in its forecast that generative AI could raise the global GDP by 7%, then it's a clear sign that the industry would continue to expand, and new applications would be entering the market en masse in the following quarters. Therefore, if generative AI truly becomes an over $1 trillion market in the next decade, then Palantir's TAM would also greatly increase and its current market capitalization of ~$35 billion could be more than justified.

That's likely one of the reasons why Palantir's shares haven't depreciated after the latest rally while Seeking Alpha's Quant system even gave the company's stock a rating of 'Strong Buy'. Add to all of this the fact that Wedbush recently decided to give Palantir a price target of $25 per share due to its competitive advantages in the coming AI revolution and we could conclude that the current AI premium at which its shares currently trade is more than justified.

The Valuation Dilemma

At this stage, the only major risk associated with investing in Palantir is the lack of clear understanding about what is the true value of its business. My DCF model from May along with the street average forecasts that are based on previous assumptions show that Palantir's fair value is in the range of $9 per share to $12 per share, which is below the current market price of ~$18 per share. However, since the beginning of summer, the generative AI field has truly taken off, but the assumptions haven't been properly revised as Wall Street is not entirely sure how big of an impact AIP will have on Palantir's financials and its valuation.

Considering this, it all comes down to whether the management would be able to convince the street why this rally has more legs to justify the current valuation at the upcoming earnings call in early August. I remain optimistic as there's a clear indication that the generative AI field would continue to expand at an aggressive rate and have a profound impact on our society. This should lead to the aggressive expansion of Palantir's TAM in the following years since the company already has a scalable product in the generative AI field that has experienced unprecedented demand since its launch a few months ago. If that's the case, then an upward revision of assumptions in my model would follow and would result in a much higher valuation that more than justifies the current market price.

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