Palantir Joins the S&P 500: Should You Buy the Stock?
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It's been a good year for investors in Palantir Technologies (NYSE: PLTR). The defense contractor that focuses on software and artificial intelligence (AI) is up over 100% year to date and now has a market capitalization of $80 billion.
Revenue is accelerating, and the company is starting to generate positive earnings and free cash flow. Investors are getting bullish on the company's push to acquire commercial customers, which are adopting its intelligence software solutions.
And it was recently announced that Palantir will be joining the S&P 500 index later this month. Investors, cheered by the news, sent the stock up more than 10%. Should you buy the stock based on its upcoming inclusion in the index? The answer might surprise you.
Let's investigate whether Palantir belongs in your portfolio today.
Index-inclusion mania
In the last few years, a narrative has formed around index inclusion and stock performance. Many investors believe that -- for reasons such as forced buying by index-focused funds -- a stock is worth more because it is included in the S&P 500. This is why Palantir shares are soaring close to all-time highs at the moment.
To be clear: This is pure nonsense and should only be looked at as speculation. A stock is worth what the underlying business generates in cash flow that is distributed to shareholders (discounted back to today).
Does this have anything to do with what index the stock is listed on? No, of course not. With Palantir, we have an example of a mimetic narrative taking hold: People believe that a stock will go up because other people tell them that index inclusion matters and thus will cause the stock to go up. It's flawed reasoning that has nothing to do with the financial fundamentals of the business.
Being added to an index might cause a stock to go up -- as it has with Palantir. But it tells you nothing about what a stock is worth.
A thriving business
So, how is Palantir's business doing? Quite well. Total revenue grew 27% year over year to $678 million last quarter, with U.S. commercial revenue growing 55%.
Total customer count has hit 593 and is growing every quarter. Once Palantir lands a customer and starts implementing its software and AI tools, it generally keeps growing revenue with that customer. So as its number of customers keeps growing, revenue should continue to grow as well.
Even better, Palantir is increasing its earnings and cash flow at the same time. Operating income was $292 million in the last 12 months, compared to massive losses when it went public a few years ago. The operating margin has now expanded to 12%. Free cash flow is also healthy at $696 million although the company spends a lot on stock-based compensation.