Palantir Still Has Room to Rise, and Could Be Worth Up to 20% More

Palantir (PLTR) stock still looks undervalued given its powerful free cash flow. Using a 27% FCF margin and an FCF yield of 1.5% its value is 20% higher. That gives investors a target price of over $22.00 per share. 

The stock is trading at $18.65 in morning trading on Monday, Dec. 4, down from its recent peak of $21.20 on Nov. 20. That occurred after the company released its Q3 results on Nov. 2. 

Shorting OTM puts in PLTR stock is a good income play for existing shareholders as they wait for its value to be realized. I discussed this income strategy in my last Barchart article on PLTR stock on Nov. 3, “Palantir's Free Cash Flow Surges, Pushing PLTR Stock and Its Target Price Higher.”

FCF Could Push PLTR Stock Higher

Palantir said its revenue rose 17% YoY to $558 million. This was stronger than its Q2 sales gain of just 13%. Moreover, the company's adjusted free cash flow (FCF) was $141 million, representing a 25% margin on revenue.

That implies that PLTR stock could move much higher. For example, analysts now project next year's revenue could reach $2.66 billion.

Assuming that Palantir's margin rises to 27% that brings its total adj. FCF projection to $718 million. The markets will give the stock a high valuation based on that projection.

For example, if the company were to pay out all that FCF in dividends, the stock would likely have a 1.5% yield. So, if we divide $718 by 1.5%, the valuation would be $47.88 billion.

That is $7 billion more than its market cap today of $40.88 billion, or +19.7% more. In other words, the stock could rise by 20% from here.

That puts its target price at $22.32, i.e., 19.7% over today's price of $18.65 per share.

Analysts Have Lower Price Targets

Analysts seem doubtful about the potential upside in the stock. For example, Refinitiv shows that the average price target of 14 analysts is $15.43 per share. That represents a potential drop of over 17% from today's price.

That means they must have some doubts about the company. However, a new sell-side analyst tracking service called AnaChart reports that the average of 14 analysts' price targets is $0.83 over the prior price of $20.27 (i.e., $21.10 per share). 

So, there seems to be some disagreement about how negative analysts are on the stock.

I follow a free cash flow (FCF) approach to setting our price targets. That has shown to be very reliable in the past. Nevertheless, shareholders may have to wait for the price target we have delineated to come to pass. One way to make that profitable is to sell short out-of-the-money (OTM) near-term expiration put options for income.

Shorting OTM Near-Term Puts for Income

For example, look at the put option expiration period ending Dec. 29, which is 25 days away. This shows that the $17.00 strike price, which is over 11% below today's price, still have a high premium of 33 cents.

That represents a yield of 1.94% (i.e., $0.33/$17.00) to the short seller. Moreover, for those willing to take on more risk, the $17.50 strike price has a 45-cent premium. That represents a 2.57% immediate yield (i.e., $0.45/$17.50).

PLTR Puts expiring Dec. 29 - Barchart - As of Dec. 4, 2023

This means that the investor shorting these puts can make good income while they wait for PLTR to rise. Their downside risk is that the stock falls and they would be obligated to purchase (not sell) 100 shares of PLTR per put option contract shorted.

That might result in an unrealized loss. But at least the investor has not had to sell any of their shares. Moreover, they can wait for PLTR to regain its footing. They can also then sell short covered calls with these new shares.

Keep in mind as well that the investor can repeat this trade every 25 days. That works out to an annualized expected return (ER) of over 27% for the $17.00 strike price as there are 14 periods of 25 days in a year (i.e., 14 x 1.94% = 227.16%). For the $17.50 strike price, the annualized ER is 36% (i.e., 14 x 2.57% = 35.98%).

These same yields may not always be available each time. But this goes to show that the trade right now is very profitable on a long-term basis. It means that it is worthwhile for existing shareholders to take on this risk while they wait for the target price to be hit.

On the date of publication, Mark R. Hake, CFA did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.