Prediction: This artificial intelligence (AI) software company could be the next Palantir

For some time, the surrounding view Palantir Technologies (PLTR 3.57%) was stuck somewhere between a generational software developer or an “AI impostor,” depending on who you ask. One of the biggest reasons for this polarizing view is that many investors simply don’t understand what Palantir actually does.

Juxtaposing industry buzzwords like “AI” and “data-driven insights” will only get you so far. At some point, a business has to prove that its marketing tactics are paying off. And in fact, in the past year, Palantir has seen a new wave of growth thanks to its range of data analytics software platforms.

The company not only accelerated its top line, but steadily expanded its profit margins and went from a cash-burning operation to a profitable enterprise. Recently, Palantir became a member of S&P 500 and works closely with some of the largest incumbents in the technology sector including Microsoft and Oracle.

Today, another company in this sector deserves a closer look: Service Now (NOW 0.41%). Have you ever heard of her? I’ll break down how ServiceNow is quietly disrupting the enterprise software world — similar to what Palantir did. Furthermore, I will explore how AI is playing a major role in the company’s current growth trajectory and assess whether now is a profitable opportunity to acquire shares.

What does ServiceNow do?

About a year ago, ServiceNow CEO Bill McDermott interviewed David Rubenstein — a private equity investor and former political adviser during President Jimmy Carter’s administration.

Asked what ServiceNow actually does, McDermott simply referred to the company as the “IT backbone” for companies looking to build digital infrastructure. While I appreciate the metaphor here, I will admit that this explanation is still a bit vague.

Let’s look at an example to better understand the ServiceNow platform. From finance, sales and marketing, operations, human resources and IT management, corporations have a separate department for almost everything. As a result, organizational workflows can move slowly and employees can be left waiting for an optimal solution for hours or even days.

This is where ServiceNow comes in. The company offers a comprehensive suite of SaaS-based tools and services designed to help streamline generic inefficiencies within organizations. This helps employees and team members better track the status of important issues or projects, ultimately leading to greater productivity.

Image source: Getty Images.

How is AI a tailwind for ServiceNow?

Like many software companies, ServiceNow is looking to ride the AI ​​wave. And on the surface, the company seems to be doing a good job. Since AI became the talk of the town, ServiceNow has signed several high-profile partnerships with Microsoft, IBMand Nvidiato name just a few. But as we alluded to, marketing strategic alliances and doing high-profile interviews is only part of the equation.

How does the ServiceNow business actually work? Pretty firm if you ask me.

Data NOW Revenue (Quarterly) by YCharts

As shown in the chart, ServiceNow’s revenue and gross profit margin have grown significantly over the past few years. Diving a little deeper here, look at growth trends starting in 2023 — around the time AI started landing on more radars.

Over the past 20 months or so, ServiceNow’s revenue line is beginning to witness a significantly steeper slope, while profit margins are simultaneously expanding. What’s even better is that the combination of accelerating sales and wider margins leads to consistent profitability — from both a net income and free cash flow perspective.

Is ServiceNow stock a buy right now?

Although ServiceNow is consistently profitable, the magnitude of net income and cash flow fluctuates quite a bit. Remember, ServiceNow is a growing company, so it constantly reinvests excess profits back into the business.

For this reason, using profit-based valuation metrics such as price-to-earnings (P/E) or price-to-free cash flow (P/FCF) is not entirely useful. Instead, I’ll look at the ratio of enterprise value to revenue.

NOW EV to Revenue data by YCharts

Right now, ServiceNow is trading at an EV-to-sales multiple of 18.6 — essentially in line with its five-year average. But if you take a closer look at the overall trends, there is a lot that can be gleaned from these charts.

After a brief burst in 2020, both ServiceNow and Palantir’s valuation multiples compressed quite significantly between 2021 and 2023. Much of this was due to macro factors such as inflation and rising interest rates , and their impact on the enterprise software market as a whole.

However, as the dawn of AI appeared around 2023, ServiceNow and Palantir began to witness some valuation expansion. What’s strange is that even with this valuation expansion, ServiceNow’s EV revenue is basically back to where it was a few years ago.

When you consider that ServiceNow is a much larger and more profitable enterprise today compared to 2020, I think there’s an argument to be made that the stock is undervalued — despite the gradual increase in valuation over the past two years.

To me, the market is starting to catch up with ServiceNow, more or less like it did with Palantir. However, I still believe that ServiceNow is not yet fully appreciated for how it plays a critical role at the intersection of AI and enterprise software.

For these reasons, I think now is a great time to buy ServiceNow stock, and I see the company following a very similar narrative and trajectory to Palantir’s as the AI ​​narrative continues to take shape.