Better Artificial Intelligence Stock: Palantir vs. Microsoft

Palantir Technologies (PLTR 4.49%) and Microsoft (MSFT -0.68%) have both profited from the rapid expansion of the artificial intelligence (AI) market.

Palantir aggregates large amounts of data from disparate sources to help its clients make faster decisions, and it's streamlining that process with generative AI tools.

Microsoft owns the world's largest PC operating system (Windows), the leading productivity software suite (Office), and the second largest cloud infrastructure platform (Azure). It's also the top investor in OpenAI, the creator of ChatGPT, and it's been integrating that start-up's generative AI tools into its own services.

Over the past 12 months, Palantir's stock has soared more than 170% as Microsoft's stock rose by less than 20%. Let's see why Palantir outperformed Microsoft by such a wide margin -- and if it's still the better AI stock for growth-focused investors.

Palantir has a bright future, but its valuations are overheated

Palantir operates two main platforms: Gotham for its government customers and Foundry for its commercial customers. Most U.S. government agencies already use Gotham to manage their data, and Palantir says its ultimate goal is to become the "default operating system for data across the U.S. government." It has also been expanding Foundry to lock in large commercial customers.

After going public through a direct listing in 2020, Palantir claimed it could grow its revenue by at least 30% annually through 2025. Its revenue rose 47% in 2020 and 41% in 2021, but it grew just 24% in 2022 and 17% in 2023.

It attributed its deceleration to the macro headwinds for enterprise software spending and the uneven timing of its government contracts. But as its sales growth cooled off, it aggressively cut its spending and stock-based compensation expenses. As a result, it turned profitable on the basis of generally accepted accounting principles (GAAP) in 2023.

For 2024, Palantir expects its revenue to rise 26% as it stays profitable on a GAAP basis. That growth was driven by its new government contracts (partly because of the ongoing conflicts in Ukraine and the Middle East), the accelerating growth of its U.S. commercial business, and the rising demand for its generative AI services. Its consistent profits also led to its inclusion in the S&P 500 this September.

Analysts expect its revenue and earnings per share (EPS) to grow 26% and 148%, respectively, for the full year. From 2023 to 2026, they expect its revenue to have a compound annual growth rate (CAGR) of 23% as its EPS has a CAGR of 59%.

Those growth rates are impressive, but its stock trades at a whopping 186 times next year's estimated earnings. That high multiple suggests that it's still being propped up by the buying frenzy in AI stocks.

Microsoft is still growing at a healthy clip with reasonable valuations

Over the past decade, CEO Satya Nadella pushed Microsoft through a grueling "mobile first, cloud first" transformation, which ultimately reignited its growth. Under Nadella, the tech giant transformed Office's desktop software into cloud-based services and mobile apps, expanded Azure to keep pace with Amazon Web Services, and transformed Windows into a central hub for its cloud, mobile, and AI services. It also continued rolling out new hardware devices and expanding its Xbox gaming unit with bold acquisitions.

From fiscal 2020 to fiscal 2024 (which ended this June), Microsoft's revenue had a CAGR of 14% as its EPS experienced a CAGR of 20%. Most of that growth was driven by Azure, which expanded rapidly as more companies upgraded their cloud infrastructure to handle the soaring usage of mobile, cloud, and AI services.

Microsoft's big investments in OpenAI also paid off as it bundled together the start-up's generative AI tools in its Copilot platform for Windows PCs and mobile devices. Those services bolstered Bing's position against Alphabet's Google in the search market, united its productivity services with AI algorithms, and connected more mainstream users to its generative AI tools.

From fiscal 2024 to fiscal 2027, analysts expect revenue and EPS to both experience a CAGR of 15%. The stock still looks reasonably valued at 27 times next year's earnings, and it could remain one of the safest ways to profit from the long-term expansion of the cloud, AI, and gaming markets. It could also be lifted by unexpected tailwinds if U.S. antitrust regulators force Google to spin off Android or Chrome.

The better buy: Microsoft

Palantir has a bright future, but too much of its expectations are already baked into its sky-high valuations. Microsoft represents a more balanced way to profit from the secular expansion of the AI market. So for now, I think it's smarter to stick with Microsoft than chase Palantir's feverish AI-driven rally.