Palantir (NYSE:PLTR) has been one of the hottest stocks of the year, up around 275% at the time of writing. However, much of that gain came on the heels of Palantir’s huge third-quarter earnings numbers; the stock price rose 23% the next day. But that strength continued well beyond the day after the earnings report, as the stock is now up 56% since the company announced stellar results on November 4.
Clearly, many investors are piling into Palantir stock, but is that a good idea? After all, the stock has had a huge run-up and sky-high expectations have been built in.
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Palantir is an artificial intelligence (AI) company that has made a name for itself by creating custom AI models for government. Eventually it expanded into the commercial space. As of the third quarter, government activities still make up the majority of revenue, but the distribution is very narrow: government revenues account for 56%.
Palantir’s AI model provides decision makers with real-time guidance based on the data received. This is useful in any situation where real-time decisions need to be made quickly and accurately. Given that this is a large part of what governments and companies do, it makes sense that Palantir’s business is growing rapidly, with many customers rushing to implement AI into their systems.
Another important product that Palantir has introduced is the Artificial Intelligence Platform (AIP). AIP enables its customers to integrate AI into the internal workings of a business, making AI a tool that is not just used as an aside. That’s a key differentiator compared to many AI products out there and has been a major reason for Palantir’s great results.
In the third quarter, Palantir’s revenue rose 30% year over year to $726 million. In particular, US commercial revenues rose 54% year over year. Should this demand spread globally, it wouldn’t be excessive to see overall revenue growth accelerate to that level.
Furthermore, Palantir is not a company that wants to grow at any cost. It is highly profitable, delivering a 20% profit margin in the third quarter.
These are fantastic results that investors should be happy with. However, if the stock’s exuberance has priced in all future growth, then there is no reason to continue owning the stock going forward. I’m afraid we’ve reached that point because the expectations built into Palantir stock are quite high.
While 30% revenue growth is impressive, that’s not the case That impressive. AI leader Nvidia had several quarters of revenue growth above 200%, and even as growth slows, Nvidia is still expected to grow revenue by about 80% next quarter.
However, Palantir is now trading at levels that Nvidia stock never reached.
Because Palantir has a more expensive price tag than Nvidia despite having an order of magnitude slower revenue growth, it doesn’t pass the smell test.
Moreover, when you consider the expectations that are now built into the stock, it’s clear that Palantir has risen too far, too fast.
Let’s say the target for Palantir stock is to trade for 50 times trailing earnings (still a very expensive valuation). Furthermore, let’s assume that Palantir maintains its 30% revenue growth and current 20% profit margin. At that rate, it will take more than six years to reach that valuation.
That assumes two things: first, the share price does not deviate from current prices, and second, the number of shares does not increase. Considering that Palantir’s stock is up 3.5% over the past year, that’s a bad assumption and would further increase the amount of time it takes to reach our target.
In reality, Palantir has probably already priced in about seven years of growth in its stock price at its current growth rate and profitability level. This is a huge figure and probably won’t work out well for investors. Therefore, I think it is best for investors to avoid the stock or at least trim some of their gains. Few stocks (if any) have ever traded and topped out at more than 50 times sales. If Palantir tripled its revenue like Nvidia did in its prime, I wouldn’t have the same opinion, but 30% revenue growth just isn’t going to cut it at the current valuation.
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Keithen Drury has no positions in the stocks mentioned. The Motley Fool holds positions in and recommends Nvidia and Palantir Technologies. The Motley Fool has a disclosure policy.
Investors are piling into Palantir stock after earnings soar. Should you follow? was originally published by The Motley Fool
