Sorting through what is signal and what is noise as an investor is a key part of being successful. When you see a glaring signal, not acting on it can be a disaster. One area where I'm seeing a flashing signal is in Palantir's (PLTR 0.46%) stock.
Palantir had one of the best 2024s of any stock, let alone an artificial intelligence (AI) company, rising 356%. However, most of that run-up has to deal with hype and fluff around the stock, and the stock has become disconnected from the actual company. As a result, I think it's best if investors take their profits and invest elsewhere, as this one metric is screaming to sell the stock.
Palantir's AI product is a hit in the U.S.
To understand why Palantir has run up so much, let's look at what the coming does. Palantir makes software that takes as much information as possible, processes it, and then gives the user real-time information about what actions they should take. This is a fairly simple concept in general, but it isn't easy to do, which is why Palantir stands out in the industry.
Another reason Palantir stands out is that it started with government contracts. Originally, it was solely used for government purposes, but the company expanded its reach to the commercial side when it saw demand for its product.
Lately, a lot of the demand has been driven by the company's Artificial Intelligence Platform (AIP). AIP allows its clients to weave Palantir's AI into a business's inner workings rather than use it as a tool on the side. This integration takes AI to the next step and has been a huge growth driver for Palantir.
NASDAQ: PLTR
Key Data Points
This boom spilled over to Palantir's financial results, with third quarter revenue rising 30% year over year to $726 million. However, U.S. commercial saw even better results, with revenue rising 54% year over year to $179 million. With only 321 U.S. commercial clients, Palantir seems to have a huge runway.
But there's a catch.
Palantir's software isn't cheap. If you annualize Q3's U.S. commercial revenue and then divide it by the customer count, you'll get an average spend per customer. That comes out to $2.23 million, which shows how expensive this software is. There isn't a large list of companies that can afford to spend that much on software, so Palantir's customer base is fairly limited.
Furthermore, when you're within the range of companies that can afford that cost, there are also other options. Outsourcing the AI work to a consulting firm like Accenture (ACN 2.69%) is one option, or building it in-house is another. Either way, the sky is not the limit for Palantir; there is still a firm ceiling unless they launch a lower-tier product.
Regardless, Palantir will continue to succeed, as it still has a large market to capture. However, it isn't as big as some bullish investors believe. This is a problem, as the stock assumes the sky is the limit.
Palantir's valuation makes no sense
From a valuation standpoint, Palantir's stock has gotten out of control. The stock trades for 378 times earnings and 69 times sales. AI king Nvidia has never traded for more than 247 times earnings and 46 times sales since it began its run in 2023. Nvidia posted multiple quarters in a row in which its revenue tripled, while Palantir's is only rising by 30%. This valuation doesn't make sense and has a ton of froth baked into it.
PLTR PE Ratio data by YCharts
If Palantir could maintain its 30% revenue growth rate for five years and then achieve a 30% profit margin (a great margin for a software company), it would trade at 60 times earnings (a very expensive price tag) at today's stock price. That's right; if Palantir's stock doesn't budge for five years, it will only then achieve a reasonable valuation. Given that Wall Street analysts only expect 24% revenue growth next year, this projection is extremely optimistic.
As a result, I think investors need to take their profits and find another company to invest in, as Palantir's valuation has gotten out of control and will likely correct sometime in 2025.
