The most popular stock in the field of artificial intelligence (AI) software is undoubtedly Palantir (NYSE:PLTR). Shares are up a whopping 160% this year, dwarfing the performance of the software company they most want to be when they mature: Adobe (NASDAQ: ADBE).
Shares of Adobe are down 15% this year, but it also belongs in the AI conversation because it is heavily involved in the AI image generation and AI video markets. However, despite Palantir’s great year and Adobe’s bad year, Wall Street thinks investors would be wise to sell Palantir and buy Adobe.
Why? Well, the answer revolves around appreciation.
Palantir’s AI platform is designed to provide the most up-to-date information to everyone with decision-making power. It involves processing multiple data streams simultaneously and then harnessing the power of AI to make recommendations. Originally designed for government use, this software has also found its way into the commercial sector.
More recently, Palantir’s new product, Artificial Intelligence Platform (AIP), has gained popularity. With AIP, companies can build generative AI into their business systems, moving AI from a tool that someone could use on the side to one that is integrated into workflows. This is a crucial step because it determines what information a large language model sees and prevents sensitive information from ending up in another company’s database.
Adobe is not as technologically advanced as Palantir. The product suite is the industry standard for graphic design, but Adobe isn’t asleep at the wheel. It has added Firefly to its product lineup, allowing creators to customize images or create new ones with text input. However, many generative AI models already have this capability, so Firefly doesn’t differentiate it.
Few models can generate AI video, yet Adobe is nearing the full launch of Firefly Video. Now that Adobe is at the forefront of this fundamental change in the way people work, it is not in danger of being replaced anytime soon. However, the stock no longer receives as much respect as it used to.
Both Palantir and Adobe have legitimate investment thesis and are strong AI companies. However, Wall Street is much more bullish on Adobe than Palantir, and I agree.
Wall Street currently has an average price target of $27.67 for Palantir stock, which suggests a downside of about 35%. Adobe’s average one-year target is $621.15, which indicates an upside of about 25% (both consensus targets come from TipRanks).
Why the big difference? It has to do with appreciation.
While Palantir may be growing faster than Adobe, the price you have to pay for that growth is too high for many investors.
Palantir currently trades for an incredible 41.1 times revenue. By comparison, Adobe trades 41.6 times his income. That’s a huge discrepancy because investors are concerned about profits once a company reaches full maturity.
To illustrate how expensive Palantir is, let’s calculate how much growth it would need to reach Adobe’s valuation.
In the second quarter, Palantir grew its revenue 27%, and management expects third-quarter revenue growth of 25%. But for the sake of argument, let’s say the economy can grow five years between these two projections (26%). That’s probably longer sustained growth than Palantir can sustain (Wall Street thinks revenue will grow 21% through 2025), but it’s what’s needed to achieve the outcome the stock is priced for.
Additionally, let’s say that Palantir can improve its profit margin from its current 20% level to Adobe’s 30% level. That’s a much more reasonable forecast, as Palantir has steadily improved its margins in recent quarters.
If it does both of those things, Palantir’s stock would generate $2.36 billion in profits over five years, giving it a 40.7x earnings valuation.
That’s without any change in the current share price. So if you think Palantir will be a better stock to own over the next five years, Adobe’s price should fall.
I think that’s a terrible bet, as Adobe has shown a knack for growing consistently in the mid-teens every year.
There’s little point in owning Palantir instead of Adobe because the expectations baked into the stock are outrageous. While Palantir is a flashy AI stock, you’re better off owning the strong stock that continues its steady, market-losing trajectory year after year.
Consider the following before purchasing shares in Palantir Technologies:
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Keithen Drury holds positions at Adobe. The Motley Fool holds positions in and recommends Adobe and Palantir Technologies. The Motley Fool has a disclosure policy.
Palantir vs. Adobe: Wall Street Says to Buy One AI Stock and Sell the Other was originally published by The Motley Fool
