Nvidia(NASDAQ: NVDA) is a terrific artificial intelligence (AI) company and its stock is worth buying for many reasons. These include that it dominates the rapidly growing AI chip market and its CEO Jensen Huang has a stellar track record of staying ahead of the competition.
That said, Nvidia’s massive size will make achieving strong percentage growth in key metrics — such as revenue, earnings, cash flows — more and more challenging as time goes on. All other things being equal, it’s easier for smaller companies to grow on a percentage basis.
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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 execute well, its stock has the potential to be a huge long-term winner, just as Nvidia stock has been. One key reason for this potential is the company’s fantastic business model.
Palantir is a software-as-a-service (SaaS) company that provides AI-powered software over the cloud via subscriptions. Its customers include agencies within the U.S. government and those of our allies as well as commercial customers across a broad range of industries. Its platforms help its customers use their data to increase efficiency and effectiveness.
Palantir was originally focused on U.S. government agencies involved in intelligence and defense. Its heavy dependence on government spending — which can be very lumpy — 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 business accounted for 56% of its total revenue and its commercial business brought in the other 44%.
Metric/Feature
Palantir
Year founded
2003
How long publicly traded?
4+ years (since Sept. 2020)
Led by a founder?
Yes
Market cap
$137 billion
Profitable in the most recent quarter on a GAAP* basis?
Yes
Profitable over the trailing 12-month period on a GAAP* basis?
Data source: Yahoo Finance. Data as of Nov. 11, 2024. GAAP = generally accepted accounting principles.
Palantir has not been publicly traded for that long, but it is well established. Moreover, unlike many tech companies that are relatively newly public, it is profitable.
As a point of reference, Nvidia has a market cap of nearly $3.6 trillion, as of Nov. 11. That makes its market cap about 26 times larger than Palantir’s.
Palantir has a business model the produces recurring revenue. Companies that have such business models tend to be attractive for a few reasons:
They can produce very high operating and profit margins.
They can generate powerful operating cash flow margins (operating cash flow/revenue) and free cash flow margins (free cash flow/revenue).
Their revenue streams tend to be more stable.
They tend to have relatively low capital expenses. In the case of SaaS companies, they’re not selling a physical product, which means they don’t have to invest in manufacturing plants.
As long as Palantir keeps it existing customers happy, it should be able to count on most of them renewing their subscriptions and some of them increasing their spending on subscriptions. This is a huge positive because it’s often time-consuming and expensive for companies to acquire new customers.
Indeed, Palantir is pleasing its existing customers. In the third-quarter, its net-dollar retention rate was 118%, CFO Dave Glazer said on the company’s third-quarter earnings call. This means that its existing customers from the year-ago quarter increased their spending on its products by an average of 18% over the last year. Though, of course, Palantir is also growing by adding new customers.
Company
Adjusted Operating Margin (MRQ)
Adjusted Profit Margin (MRQ)
Operating Cash Flow Margin (MRQ)
Free Cash Flow Margin (MRQ)
Palantir
38%
33%
58%
57%*
Microsoft(NASDAQ: MSFT)
47%
38%
52%
29%
Data sources: Companies’ earnings reports. MRQ = most recent quarter. Operating margin = income from operations/revenue; profit margin = net income/revenue; cash flow margins were previously defined.
I chose Microsoft as a comparison company because it’s software-focused, and known for its high profit margins and strong cash flows. In other words, it’s a tough comparison — and look how well Palantir stacks up.
One number might stick out to you — Microsoft’s free cash flow margin. The reason it is much lower than the company’s operating cash flow margin is because Microsoft has high capital expenditures. Namely, it has to invest in data centers to keep its cloud computing service business competitive.
If you’re a long-term investor, the first thing you should do when considering buying a stock is to delve into a company’s business model. You can learn a lot about its business model by just looking at how it makes its money. Of course, there are other factors to consider, such as what are its advantages relative to potential competitors? Who is the target market? How potentially big is the target market?
Companies that have subpar or just OK business models can do well over the short term, and their stocks might even soar over the short term. But the stocks of these companies are not going to be huge winners over the long term.
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Beth McKenna has positions in Nvidia. The Motley Fool has positions in and recommends Microsoft, Nvidia, and Palantir Technologies. The Motley Fool recommends the following options: long January 2026 $395 calls on Microsoft and short January 2026 $405 calls on Microsoft. The Motley Fool has a disclosure policy.
