Is BigBear.ai Stock in Trouble?

Key Points

• BigBear.ai badly missed expectations in its most recent quarter.

• A decline in government spending drastically affected its top line.

• Without a significant improvement to its gross margins, it's unlikely that BigBear's bottom line will get out of the red anytime soon.

• 10 stocks we like better than BigBear.ai ›

BigBear.ai Holdings (NYSE: BBAI) has been a volatile stock to hold over the past year, with its price ranging between a low of $1.26 and a high of $10.36. Recently, the company reported earnings, and it has once again disappointed investors, sending BigBear's stock back into another tailspin.

For all the hype and excitement surrounding the company's artificial intelligence (AI)-powered business software, BigBear has failed to deliver strong results time and time again. In its most recent quarter, the company not only badly missed expectations, but it also slashed its guidance.

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Is the stock in trouble, and could this be the start of a much bigger and prolonged sell-off for the tech company, or could BigBear make for a good contrarian buy today?

Image source: Getty Images.

Big miss highlights the company's dependency on government contracts

On Aug. 11, BigBear reported its quarterly numbers for the period ending June 30. Revenue of $32.5 million declined by 18% year over year, and the company's operating loss grew from $16.7 million to $90.3 million. With numbers like that, it's not much of a surprise that the stock fell after the release of the report. Wall Street analysts were expecting revenue to come in around $40.6 million.

The reason for the big drop in revenue was a result of "disruptions" in the federal contracts the company has with the government, particularly with programs supporting the U.S. Army. The government's "efficiency efforts" have impacted not only this past quarter's results but also resulted in BigBear reducing its guidance for the full year. The company now anticipates its full-year revenue will be within a range of $125 million to $140 million, versus its previous guidance of $160 million to $180 million.

For investors, the concern is that government spending can have a significant impact on BigBear's financials and dictate its growth. The company needs to diversify its customer base; otherwise, government cutbacks could continue to weigh down its top line in the future.

Lack of revenue growth isn't BigBear's only problem

It's bad news for a growth stock to show no growth, and for its sales to actually decline on a year-over-year basis. But a more troubling issue I see is that BigBear's gross profit margins are low for a software company. It reported a gross margin of $8.1 million last quarter, which was just 25% of its top line.

Many investors see BigBear as potentially being the next Palantir Technologies. But consider that Palantir's gross margins are far stronger -- about 80% of revenue, which enables the data analytics company to comfortably post a profit.

If BigBear isn't generating enough gross profit, that will make it incredibly difficult for the company to get anywhere near breakeven. And it may also suggest that it is pricing its software solutions too low, perhaps for the sake of growing revenue. But without strong margins, revenue growth alone isn't going to make BigBear a strong company to invest in.

BigBear has a lot of work to do before it becomes a good stock to own

For BigBear to be a good business to invest in, it needs to diversify its operations so that it isn't so dependent on government spending. It also needs to improve its gross margins. Without those two things, it's going to be extremely difficult for the company to consistently grow its top line and have any hope of becoming profitable in the foreseeable future.

Until that happens, I would suggest staying away from the stock as BigBear has been a highly risky and volatile investment to hang on to thus far, and I don't think that's going to change anytime soon.

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