What happened

On Tuesday morning, Palantir Technologies (PLTR 1.56%) reported third-quarter results that ranked right up there with the best this period among defense IT companies. But it also didn't offer much reason to believe that investors will need to view it as anything other than a defense IT company any time soon.

Shares of Palantir fell by as much as 10% in morning trading, and were off by 8.8% as of 12:26 p.m. EST.

So what

Palantir, best known as the company whose tech helped locate Osama bin Laden, went public about a year ago and immediately shot higher as the market considered the potential commercial-sector applications for its data analytics tools. Throughout its nearly two-decade history, it has been mostly focused on government contracts. But those tend to be low-margin contracts, and investors thus far have valued Palantir more like a commercial software vendor than a government-focused one.

Illustration of three IT professionals working in a secure cloud environment.

Image source: Getty Images.

The company reported third-quarter adjusted earnings of $0.04 per share on revenue of $392 million, matching expectations on earnings and beating the consensus sales forecast by about $7 million. It has been a tough quarter on the government side of the business, with numerous contractors reporting revenue slowdowns, but Palantir's business showed strong resilience.

The issue, though, is that Palantir remains a very defense-focused business. Government contracts accounted for nearly 56% of total sales, and that segment is growing at nearly the same pace as its commercial business. If those trends continue, Palantir will remain closely tied to the defense business for the foreseeable future. As such, it's going to be hard-pressed to deliver the growth rates that investors envisioned when it first went public.

PLTR Chart

PLTR data by YCharts. Chart measures from the date of its IPO.

Now what

Palantir today trades at more than 30 times expected 2022 sales. By comparison, the largest government IT vendors -- including Booz Allen Hamilton, Leidos Holdings, CACI International, and Science Applications International -- all trade at levels between 1.3 times and 0.7 times expected sales.

Palantir is a strong company with fantastic technology, but I have been saying for nearly a year now that if it doesn't quickly show real progress in its transformation into a commercial IT vendor, the market will likely reassess its expectations -- and its valuation.

The stock has been treading water for some time now, and is actually trailing the S&P 500 year to date by nearly 20 percentage points. This latest quarterly report, while strong, holds no indications that the company's working to change the narrative about what it is or who its core client is. Tuesday's sell-off is likely simply part of the process of the market resetting expectations.