Palantir Technologies (PLTR 0.97%) has become one of the hottest stocks on Wall Street. Since the start of 2024, the stock has risen around 630%, making it one of the best performers in the entire market.
If you've positioned yourself well enough to capture all of these returns, congratulations! But there is one mind-blowing metric that Palantir investors need to be aware of, and it may cause you to change what you're doing with Palantir shares.
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Palantir's platform has proven its value multiple times
Palantir has risen to the top due to its dominance in deploying AI solutions for its clients. Although what Palantir actually does is quite complicated, it can easily be summed up as "data in, insights out." This simple explanation for Palantir's business requires a ton of artificial intelligence (AI) work in the middle, but the results are astounding. For one example, Wendy's used Palantir to solve a supply chain problem that used to "go on for weeks and days" and fixed it in five minutes. Heineken's chief operating officer stated that the company used Palantir AI to optimize delivery and shipping in just three months -- a task that previously took three years to accomplish.
There are countless examples of Palantir transforming businesses, but it's also deeply involved in government.
When it first started, governments were Palantir's primary clients, and it only recently pivoted to offering its technology to companies as well. Government revenue remains a key part of Palantir's business today, and it generates more revenue than its commercial segment. In Q1, government revenue grew 45% year over year to $487 million while commercial revenue rose 33% to $397 million. Those are impressive growth rates, especially with the government, as many of its clients in that division have been using Palantir's products for years.
Additionally, government revenue is being realized globally. U.S. government revenue growth for the first quarter was 45% -- the same rate as the overall company. However, U.S. commercial growth far outpaced the global division's total, rising 71% year over year. This is a key trend, as U.S. commercial sales have been unstoppable.
But that 71% growth metric in U.S. commercial sales isn't the mind-blowing metric I want investors to know; its valuation is.
The stock has a ton of growth baked into it
Although Palantir's stock price has risen around 630% since the start of 2024, revenue only increased by 40%. That's because the market is willing to pay more for Palantir's business than it did in the past. This is called multiple expansion, and causes the multiple on the stock to rise.
That's exactly what has happened with Palantir's various valuation metrics.
PLTR PE Ratio (Forward) data by YCharts
Whether you use Palantir's forward price-to-earnings (P/E) ratio or price-to-sales (P/S) ratio, Palantir's stock is unbelievably expensive, and investors should be concerned about an imminent crash.
Few companies can sustain a high valuation level, and nearly all crash at some point due to extreme expectations. Let's do a quick check to see what assumptions are baked into the stock price:
- Let's assume Palantir can accelerate its revenue growth from 39% year over year in Q1 to 45%, and it can sustain that rate for the entire period.
- Palantir is still working toward optimizing profitability, but the best software companies achieve a 30% profit margin. So, we'll set that as Palantir's ending profit margin.
- We'll also ignore the effects of stock-based compensation. This is a bad assumption because Palantir's share count has risen by over 5% over the past year, but it gives Palantir the benefit of the doubt.
If all three assumptions become true over five years, Palantir's revenue will grow from $3.1 billion to $20 billion, and profits will rise from $571 million to $6 billion. That is monster growth, but does it justify today's valuation? If Palantir could generate $20 billion in revenue and $6 billion in profits, it would be valued at 14 times sales and 48 times earnings. Those are far more typical valuations for a growth stock, and nearly match what Nvidia trades at today (25 times sales and 45 times earnings).
Because this calculation ignores stock-based compensation effects, the actual valuation will be much higher, so it's safe to assume that at least five years of growth are baked into the stock price if even the most bullish predictions come true.
The mind-blowing metric I want investors to be aware of is five years -- the amount of time it will take to work out all of the growth baked into Palantir's stock. This is far too high a premium to pay for a stock, and I think investors would be smart to move on from it here, or at least trim back some of the gains, as few stocks ever work out for investors that are valued this high.
