Palantir (PLTR -0.02%) has become one of the most popular artificial intelligence (AI) investments. However, it hasn't recovered from an August drop and shares remain about 25% off their 2023 high from Aug. 1.

So, is it time to pick up some Palantir shares? Or was this pullback necessary to maintain a reasonable valuation? Let's find out.

Palantir's primary customer is still government entities

Palantir's software isn't like others with some AI sprinkled into it; it was built from the ground up with AI at the heart of the platform. At its core, Palantir's software is a data analytics program that processes various data streams and either automatically makes decisions or aids humans in making the best ones possible.

Originally, Palantir's software was utilized solely at the government level, but it has since expanded to commercial customers. However, government revenue remains a vital segment, as 57% of Q2 revenue came from government sources and it grew faster than commercial clients.

Over the long term, commercial customers will become more important, as the market is larger, but investors should expect government contracts to be a massive part of Palantir's investment thesis, regardless of how far into the future they look.

While AI has been at the core of Palantir's products since inception, the latest AI fascination deals with large language models (LLMs), which are trained to generate content that sounds like it came from humans. This branch of AI exploded in popularity with ChatGPT's rise in late 2022, and Palantir quickly launched its variation, which it calls "Artificial Intelligence Platform", or AIP, to help customers integrate AI and LLMs. Management says it is seeing unprecedented demand for AIP, as both old and new customers want to deploy this technology to expand how they use Palantir's base product.

That's all good news, so why did the stock drop in August? When you look at Q2 results and the stock's valuation, it becomes clear why.

Growth disappoints

Despite talk of "unprecedented demand" and rapid adoption of AIP, Palantir isn't putting up the growth you'd expect. In Q2, revenue grew a respectable 13% year over year, and management gave guidance for 16% growth in Q3.

In a vacuum, these numbers aren't terrible. However, many investors expect more growth from a company that is seen as one of the leaders in AI proliferation and that was enjoying much stronger growth a few years ago. Its year-over-year quarterly growth rate has been dropping since late in 2021, so the predicted uptick from 13% to 16% might be seen as an indicator of a change in the trend.

Much of the slowing growth rate has been due to how expensive Palantir's software is -- Palantir only has 421 customers. Divide the most recent quarter's revenue by that and you get $1.27 million per customer. That's a lot of money for a new customer to fork over for an unproven software with questions about the economy's stability present, so it shouldn't be too surprising that Palantir isn't growing at warp speed. But Palantir's growth acceleration is a positive sign, as its growth has ticked down steadily over the past two years. With Palantir maturing as a business, investors should be content with a mid-teens growth rate just due to its customer mix and product cost. But if AIP is a game changer for the company, this could be the start of another round of exciting growth 

When a company can't grow as fast as its peers, it would make sense that it doesn't trade at as high of a multiple, but at 16 times sales, Palantir is valued at around the same level as many companies that are growing two to three times faster than it. The stock is getting a premium because it's heavily associated with AI.

PLTR PS Ratio Chart

PLTR PS Ratio data by YCharts

Because of that, I'm concerned about the stock. If AI investment hype dies down, I'd expect Palantir's valuation to regress, which won't do investors any favors. But the buzz around AI may continue and Palantir may keep proving itself, so a smaller position in the stock might be warranted, but don't expect the same 135% gains Palantir has given investors so far in 2023.