After an incredible 2023 performance, Palantir (PLTR 3.73%) shares have taken a step back. At its peak, Palantir was up over 230% for 2023, but the stock now is 22% down from those levels.
Because of Palantir's artificial intelligence (AI) software, there is a lot of interest in the stock. As a result, many investors want to know if this pullback is the start of a larger movement or a buying opportunity. So, should you buy the dip on Palantir's stock?
Palantir's software helps users make decisions streamlined by AI
While most people know Palantir is an AI-related company, some aren't sure what its software does. Palantir's software helps businesses or governments make decisions with the most up-to-date information possible. The software takes in data streams of all varieties, then goes through a custom AI model, and then gives these insights to the user.
This makes the software highly versatile, as Palantir reportedly helped track down Osama bin Laden's final hiding spot, but hospitals also use it to divert patients to other locations based on staff and bed availability.
Image source: Palantir.
The company is also integrating the generative AI game with its AIP (artificial intelligence platform). AIP ensures user data is solely contained within the company, as many clients don't want other generative AI companies to have access to their data. AIP then allows users to create programs that can automatically perform tasks or have human intervention.
Palantir is one of the top options if you want a fully custom AI model created to help make business decisions.
However, the stock has gotten ahead of itself.
Palantir's growth doesn't support its price
With how much hype AI has received, you may be surprised to learn that Palantir's revenue growth rate in the third quarter was only 17%. While 17% is still impressive compared to many companies, it's not quite quick enough to justify its valuation, which is why Palantir's stock has sold off in the past few months.
PLTR PS Ratio data by YCharts
With the pullback, Palantir's price-to-sales valuation is more reasonable, but is it at a buying point?
When a company matures, investors care about earnings. Palantir is still working on becoming fully profitable, although it has made tremendous strides throughout 2023, improving from a 6% profit margin in the fourth quarter of 2022 to a 13% profit margin in Q3. However, Palantir hasn't finished improving its profit margin, so using this figure for a future analysis isn't reasonable.
Instead, I'll use fellow software expert Adobe's profit margin (28%), as it's a mature software business. Should Palantir maintain its 17% growth rate for five years and achieve a 28% profit margin, it would generate $1.3 billion in net profits. By dividing its current market cap ($36.5 billion) by its future hypothetical earnings, you get a five-year forward price-to-earnings ratio of 28, assuming the company neither issues nor retires a ton of shares in the meantime.
Essentially, you must give up five years of growth (the stock would stay flat) and match industry-leading margins to get a reasonable price-to-earnings valuation. This makes me wonder why you'd buy Palantir's stock over a company like Meta Platforms, which trades at 21.5 times forward earnings and grew revenue at a 23% clip last quarter.
The one flaw in this analysis is that I do not know if the 17% growth rate for five years will occur. With the buzz around AI, this could be dramatically under-projecting its growth rate, which could cause me to miss a big-time winner. However, if there are other cheaper alternatives available with faster growth rates, I'll look to those first.
Palantir is a phenomenal business, and it will likely succeed and grow throughout 2024 and beyond, but it doesn't make sense as an investment at today's prices and growth rate.
