Better Artificial Intelligence Stock: Palantir or Adobe

Year to date, shares of Palantir Technologies (NASDAQ: PLTR) have soared by 326% while shares of Adobe (NASDAQ: ADBE) have tanked by 20%. However, picking a stock based largely on its recent performance is a strategy fraught with risks. Past returns are not predictive of the growth potential of a stock.

Instead, it is more prudent to analyze a company's business model, competitive positioning, risks, and the stock's volatility before making investment decisions. Based on these fundamentals, let's explore which of these two makes a better buy.

Palantir's pros and cons

Data mining and analytics specialist Palantir posted strong financials in the third quarter, with revenue and earnings handily beating consensus estimates. Revenue soared 30% year over year to $729 million, driven mainly by 44% growth in its U.S. business. Revenue for the company's U.S. government and commercial businesses grew by 40% and 54%, respectively.

Government agencies and large enterprises mainly use Palantir's data and analytics solutions for complex and mission-critical applications. This has helped the company build a sticky customer base. In the third quarter, its U.S. commercial customer count rose by 77% year over year to 321. Its U.S. government business also delivered its strongest growth in 15 quarters.

The company's Artificial Intelligence Platform (AIP) has also emerged as a major growth catalyst for the company. The platform uses multiple open-source and closed-source models and ontologies (frameworks that unify complex data sets from disparate sources and define their attributes and interrelationships) to help businesses address fundamental challenges such as finding ways to improve productivity and reduce costs.

Palantir's unique go-to-market strategy has also played a pivotal role in driving the adoption of AIP. Instead of engaging would-be clients with pilot projects that can take months for client conversion, the company demonstrates the utility of AIP in resolving real-time challenges via rapid "boot camps." This has accelerated client conversion time. In its most recent earnings call, management highlighted several large enterprises that entered into deals with seven-figure annual contract values within two months of their first boot camps.

The company's financial health has also been improving at an impressive pace. The company recorded an adjusted operating margin of 38% in Q3, its eighth consecutive quarter of margin expansion, and it had $4.56 billion cash on its balance sheet at the end of the quarter.

Despite the many strengths of the business, Palantir's sky-high valuation remains a sore spot for investors. It trades at 63.3 times trailing-12-month sales, far higher than its three-year average price-to-sales ratio of 23.2. Furthermore, the company is more exposed to government budgetary and regulatory fluctuations.

Adobe's pros and cons

A leading maker of creative software, Adobe also came out with impressive results for its fiscal 2024 fourth quarter, which ended Nov. 29. Both revenue and earnings surpassed consensus estimates. However, compared to Palantir, Adobe's revenue growth has been quite modest, up 11% year over year to $5.6 billion in the fiscal quarter. The company is highly profitable and saw non-GAAP earnings per share rise by 15% year over year to $18.42.

Furthermore, its future looks bright, with remaining performance obligations (total contracted revenue from products or services that haven't yet been delivered to clients) up 16% year over year to $19.96 billion.

Adobe has integrated several generative AI tools powered by the Adobe Firefly family of models (such as Imaging, Vector, Design, and Video models) into its flagship products in the Creative Cloud, Document Cloud, and Experience Cloud segments. As of the end of the fourth quarter, Firefly generations across all its tools totaled more than 16 billion. These AI capabilities are helping improve output quality and user control in creative content and document management.

The company has also launched Adobe GenStudio, which integrates Creative Cloud, Experience Cloud, and Firefly capabilities to manage scaled content creation in enterprises.

Adobe is now gearing up to further monetize its AI tools by offering new tiered subscription offerings and add-ons that will help bring in new users and boost its average revenue per user. The company's broad release of the Firefly Video model in early 2025 will also be a major opportunity since video generation is a higher-value activity than image generation.

The company also boasts strong financials. Its non-GAAP operating margin was 46.3% in the fourth quarter, and it carried cash and short-term investments of $7.89 billion on its balance sheet. Yet, Adobe is trading at only 8.6 times sales, far lower than its three-year average of 11.9.

Which one is better?

Palantir is a high-growth company that can expect significant revenue volatility relating to deal value and volume. Adobe is a more stable company with a broader customer base and predictable subscription revenues.

Palantir is also valued at a much richer multiple than Adobe. However, the huge gap in their valuations cannot be justified merely by the differences in their respective growth rates.

Against this backdrop, Adobe seems like the investment that would better suit the needs of retail investors with average risk tolerance, while Palantir could be a smart pick for investors with high levels of risk tolerance.

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Manali Pradhan has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Adobe and Palantir Technologies. The Motley Fool has a disclosure policy.