The fall from the top some stocks have experienced since 2021 has been incredible. Palantir (PLTR 0.19%) and DigitalOcean (DOCN 3.15%) have fallen 84% and 80% from their respective all-time highs and may never return to those highs. When a stock is down 80%, it must rise 400% to regain its previous levels. Both companies could eventually regain those levels through massive growth, but it could be a while.
But anchoring to a previous price point is a mistake, and investors need to analyze where the business is now and decide if it's worth taking a position in. After analyzing these two companies with me, you'll see why these two may be worth taking a shot on during 2023.
What do Palantir and DigitalOcean do?
Both companies focus on the direction the business world is moving in, with Palantir having a robust artificial-intelligence-fueled data analysis platform and DigitalOcean providing cloud computing infrastructure to small businesses and individuals. This is evidenced by each company's key customer growth metrics. Palantir grew its total customer count by 66% in the third quarter, while DigitalOcean's number of customers spending more than $50 per month rose by 50%.
However, the size of the customer base between these two varies dramatically. Palantir only has 337 customers, of which 228 are commercial, and the rest are various government entities. DigitalOcean has more than 142,000 customers spending $50 or more per month, showing how widely used it is.
This makes the revenue streams from both companies different, even though both operate off the subscription model. With Palantir, revenue growth could be chunky and dependent on one or two big contracts like the one-year $229 million contract it signed with the Department of Defense in September to increase its machine learning capabilities.
Because DigitalOcean has an army of customers, it's less dependent on one or two customers joining or switching. However, the overall trend is essential to keep an eye on, especially when DigitalOcean raised the price of its products by up to 20% on July 1. This is a massive part of the reason why customers spending more than $50 per month increased 66% in Q3 -- far above the standard rate.
Regardless, investors will be happy if each company continues growing its revenue and signing up new customers. But both companies will need considerable growth to start generating serious profits.
Profits aren't a given with these two
With both Palantir and DigitalOcean not maximizing profits, investors need to do some digging to see if it's a concern or a temporary risk.
Palantir posted an operating loss of $62 million in Q3 -- a 13% loss margin. While that looks bad (and it is), it's a vast improvement over last year's 23% operating loss margin. Obviously, investors want to see this metric turn positive, but with the steady improvement Palantir has made throughout the last few quarters, it's a great sign that Palantir is on track.
DigitalOcean is in better shape than Palantir, as it posted an operating profit of $9.4 million (6% margin). Additionally, operating expenses rose slower (27%) than revenue (37%), so it's controlling its expenses responsibly. Or is it?
Remember, DigitalOcean hiked its prices for the first time in company history in Q3, so this revenue growth reflects a one-time boost that will show up in DigitalOcean's results until Q3 of next year. As a result, I'm a bit worried that expenses grew faster than revenue when the effect of the price hike is eliminated.
Still, DigitalOcean is profitable, and as long as the company is responsible with expense growth going forward, it won't lose that status.
So why are these companies set to rebound in 2023?
Their valuations are absurdly low
Each company's price-to-sales ratio shows how badly these companies have sold off in 2022.
PLTR PS Ratio data by YCharts
Did these two deserve to trade for 30 or even 20 times sales? Definitely not. But, at their current valuation levels, Palantir and DigitalOcean are valued lower than many of their peers. Another software company, Adobe, hasn't traded as low as either company since it switched its business model to a subscription one in 2014.
I'm not saying either company deserves to trade at Adobe's valuation because it is one of the better software companies. However, at their current valuation levels, they are decently priced, so investors shouldn't worry about a lot more downside. There is a substantial opportunity for the stocks to rebound throughout 2023, as any stock appreciation will be linked to business growth rather than hype because of their valuations.
I think DigitalOcean and Palantir could have a strong future ahead of them, but their earnings will need to grow to achieve it. Nevertheless, with any business success, these two should have a better 2023 than 2022.
