Palantir Is Down 38% From Its High -- and It Just Got a Wall Street Upgrade. Time to Buy?

Palantir Technologies (NASDAQ: PLTR) picked up an upgrade to a buy rating this week, and the argument behind it is one bulls have waited years to hear: the earnings have finally caught up to the price. After a 38% slide from its 52-week high of $207.52, the stock trades around $129 as of this writing. A year ago, this was a company earning $0.08 a quarter. Last quarter, however, it earned $0.34.

So, have the earnings really caught up to the valuation?

Why the stock's valuation might work

While the stock was losing more than a third of its value, the business kept compounding. First-quarter revenue grew 85% year over year to $1.63 billion -- and 16% from just the prior quarter -- while U.S. commercial revenue grew 133%.

The forward indicators point in the same direction. Palantir closed 206 deals of at least $1 million during the quarter, and its closed total contract value -- the lifetime worth of new customer agreements -- reached $2.41 billion, up 61% year over year. U.S. government revenue grew 84%, meaning the commercial side is now the faster of the company's two engines.

And Palantir's recent profits have arguably been even more impressive than its top-line growth. GAAP net income was $871 million last quarter, a 53% profit margin, and earnings per share came in at $0.34. Adjusted free cash flow ran $925 million -- a 57% margin -- and the balance sheet carries $8 billion in cash and short-term Treasuries.

Software investors often judge the growth-and-profit mix with a shorthand called the Rule of 40, which adds a company's revenue growth rate to its adjusted operating margin and looks for a total above 40. Palantir's reading last quarter was 145.

Palantir now trades at about 145 times earnings and about 86 times forward earnings. This is still a wildly high valuation. But it's a fraction of what buyers were paying at the peak, when the earnings were smaller, and the price was $78 higher.

Management keeps raising the bar, too. Full-year guidance now calls for revenue of about $7.65 billion, which works out to 71% growth, and for U.S. commercial revenue to climb at least 120% -- targets the company lifted, not trimmed, when it reported in May.

What still has to go right

In short, a valuation of 86 times forward earnings might sound difficult to justify on the surface. But Palantir is no ordinary company. Its past results show a company that can achieve unbelievable growth rates. Against almost any other business, a valuation like this would take years to grow into. With Palantir's extraordinary underlying business growth, however, it may already fully justify a valuation like this.

With this said, risks persist. Government spending cycles can change, and competition in artificial intelligence (AI) software is arriving from every direction. There's a size constraint, too: at a market value of about $310 billion, Palantir already ranks among the largest software companies in the world, so the era of easy doublings is probably behind it. Finally, the downside risk if growth unexpectedly slows meaningfully is significant, with the stock trading at a valuation of 86 times forward earnings.

So, is it time to buy Palantir stock?

I personally think shares are closer to a hold here than a buy. Overall, I do think the underlying businesses could justify the current stock price. But the keyword here is "could." I'd like to see a bigger margin of safety before I buy the stock -- a price meaningfully below my estimate of the stock's intrinsic value. This way, if things go worse than expected, shares could still perform decently.

Daniel Sparks and his clients have 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.