Palantir Technologies (PLTR 1.65%) has been around for about 20 years, growing revenue primarily thanks to contracts with governments during most of that time. But over the past couple of years, this software company’s commitment to artificial intelligence (AI) and increasing its business with companies has supercharged growth.
In the most recent quarter, it generated double-digit revenue gains and the biggest quarterly profit in the company’s history.
The news didn’t boost the stock, though. As a matter of fact, Palantir shares have dipped 17% over the past three months. Investors might have been disappointed by the company’s full-year revenue guidance, which fell short of certain estimates.
Of course, we all love it when a company’s expectations beat estimates, but another element actually is more important, and this is the ability to balance revenue and profit growth. So, before making any decisions about Palantir, let’s check out this one crucial number that investors might be ignoring.
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Making better use of data
First, a bit of background. The software company specializes in helping governments and businesses aggregate their data and use it to advance certain projects or strengthen their operations. And just last year, management launched its Artificial Intelligence Platform (AIP), integrating this newish technology with the expertise Palantir has developed over time.
Commercial customers have flocked to Palantir, realizing that savvy management of data can lead to more efficiency, eventually saving time and money — and can open the door to new growth opportunities. In the quarter, its U.S. commercial revenue rose 40%, and U.S. commercial customer count climbed 69%.
As mentioned, the company’s overall quarterly revenue and profit came in strong — but management’s forecast for full-year revenue of $2.68 billion to $2.69 billion missed a consensus estimate of $2.71 billion. It’s important to remember that the lowest Palantir forecast still represents 20% growth from last year’s revenue level.
On top of this, another number — the one some investors may not have noticed — is looking good. I’m talking about the Rule of 40, a calculation combining the revenue growth rate and profit margin. When a company attains and maintains a Rule of 40 score of 40% or higher (Palantir registered a 57% in its latest quarter), it’s a positive sign. Those with a lower percentage could face cash-flow problems.
A Rule of 40 success story
As you can see in the chart below, Palantir has maintained a 40% or significantly higher score for six of the past eight quarters. And over the past three quarters, its Rule of 40 score has truly taken off, growing from 46% to 57%.
This is a great sign because it indicates management isn’t just pouring investments into revenue growth but also is focusing on translating that growth into profitability — and it’s succeeding. At the same time, growth in commercial customers and soaring demand for the company’s AIP boot camps (sessions to introduce the AIP platform to potential customers) should keep revenue climbing. And this offers an ongoing opportunity to keep increasing profit.
Palantir’s success as measured by the Rule of 40 also makes this company stand out among its peers. Only about a third of software companies succeed under the Rule of 40, and even fewer maintain that success, according to McKinsey & Company research. In a McKinsey analysis of 200 software companies over the period of a decade, they surpassed Rule of 40 performance about 16% of the time.
Palantir’s success under that rule offers us reason to be confident about its ability to continue along the profitability path. And it shows us the company is among top players in the industry by this measure.
McKinsey noted successful Rule of 40 companies set realistic growth targets and adjust their cost structure accordingly. So I’m not disappointed that Palantir’s annual growth target fell short of certain estimates. Instead, it demonstrates wise management of the revenue/profitability equation.
Now, what does this mean for you as an investor? Should you buy the stock on the dip? There’s no guarantee it will rebound overnight. But it offers many positives today and into the future: The company is profitable, revenue is on the rise, the commercial business is growing, and it’s a solid player in the AI space.
All of this together leaves me optimistic about Palantir’s future, making this a great stock to buy on the dip and hold on to for the long term.