For more than two years, no trend has captivated the attention and pocketbooks of investors quite like the rise of artificial intelligence (AI). The ability for AI-empowered software and systems to make split-second decisions without the oversight of humans is a technology with broad-reaching potential in most industries around the globe.
In Sizing the Prize, the analysts at PwC estimate a combination of productivity improvements and consumption-side effects from AI will boost worldwide gross domestic product by 26%, or $15.7 trillion, come 2030. If this figure is even remotely accurate, it means a long list of companies will benefit from this game-changing technology.
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Although graphics processing unit (GPU) kingpin Nvidia is often viewed as the face of the AI revolution, a strong argument can be made that it's been surpassed by AI- and machine learning-driven data-mining specialist Palantir Technologies (PLTR -0.67%). When 2023 began, Palantir was a company of fringe importance in the tech sector. But following a greater than 2,000% gain in two and a half years, it's become the eighth-largest publicly traded U.S. tech stock.
But in spite of everything seemingly going its way, it's my expectation that Palantir stock will plunge to $55 (representing a decline of 60%), at minimum, by 2027.
Palantir's sustainable moat and operating model speaks to Wall Street and investors
However, before making predictions about the future, it's imperative to understand how Palantir's $330 billion market cap foundation was built.
The primary reason Wall Street and investors love Palantir so much is simple: it offers a sustainable moat. The company's two core operating segments -- Gotham and Foundry -- lack large-scale competition. When public companies have no clear one-for-one replacement and don't have to look over their proverbial shoulder, they tend to be rewarded with a hefty premium by the investing community.
Something else Palantir brings to the table that investors seem to appreciate is its operating cash flow predictability. Gotham, which services federal governments by aiding with mission planning and execution, as well as data collection/analysis, typically lands multiyear contracts. Meanwhile, the enterprise-focused Foundry platform, which helps businesses better understand their data, is a subscription-based model. Wall Street loves predictability, and a lot of Palantir's sales can be forecast multiple years in advance.
Speaking of forecasting, Palantir shifted to recurring profits well ahead of the consensus from Wall Street analysts. The company has demonstrated that its operating model is viable and time-tested.
Another reason investors have piled in is the company's pristine balance sheet. Palantir Technologies closed out the March-ended quarter with $5.43 billion in cash, cash equivalents, and marketable securities, with no debt. This mammoth cash pile allows CEO Alex Karp to aggressively invest in platform innovation(s), as well as reward shareholders with occasional stock buybacks.
The icing on the cake for Wall Street and investors -- aside from Palantir's sustained annual sales growth of between 25% and 35% -- is Donald Trump's November victory. Historically, Republican-led governments have favored strong defense spending. Further, Trump is a big proponent of national security and making America an AI leader. It's the ideal situation for Gotham (Palantir's leading platform) to thrive.
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Two reasons Palantir stock to $55 by 2027 is highly probable, based on history
When viewed with a wide lens, Palantir is a fantastic business with a sustainable moat that's utilizing AI and machine learning to sustain a double-digit sales growth rate. But even fantastic businesses can run into historical headwinds.
While I don't deny that Palantir is cash-rich, profitable, and capable of sustaining its competitive moat, its premium valuation will almost certainly come under pressure over the next two years due to two factors.
To begin with, there hasn't been a game-changing technological innovation or hyped trend for more than three decades that's managed to avoid an early stage bubble-bursting event. In other words, every major technological advancement since (and including) the advent of the internet in the mid-1990s has seen investors overestimate early innings adoption and/or utility.
There's no question America's most-influential businesses have an appetite for AI hardware and applications at the moment. Nvidia's skyrocketing sales are evidence of businesses wanting to be on the leading edge of the AI revolution within their respective industries. But what we're not seeing is evidence of businesses optimizing their AI solutions or consistently generating a positive return on their AI investments. Without exception, every next-big-thing technology has needed time to mature, and AI simply isn't there yet.
The good news for Palantir is its multiyear contracts via Gotham and subscriptions from Foundry would help insulate its top-line results from an immediate drop-off if the AI bubble bursts. Unfortunately, investor sentiment would still be expected to weigh heavily on Palantir stock, if history were to repeat.
The second significant downside catalyst for Palantir stock, based on what history has to say, is its valuation. Although a premium valuation multiple is warranted for companies that boast a sustainable moat, Palantir stock has pushed this premium into the stratosphere.
PLTR PS Ratio data by YCharts. PS Ratio = price-to-sales ratio.
Prior to the bursting of the dot-com bubble a quarter of a century ago, prominent internet-driven businesses like Microsoft, Cisco Systems, and Amazon saw their respective price-to-sales (P/S) ratios catapult higher. Something similar occurred with AI-GPU giant Nvidia last summer. Though their trailing-12-month (TTM) P/S ratio peaks all occurred at different times, these four companies topped out at TTM P/S ratios ranging from about 30 to 43.
As of the closing bell on June 20, Palantir's TTM P/S ratio was tipping the scales at (drum roll) 110! No megacap company on the leading edge of a next-big-thing trend has been able to maintain a TTM P/S ratio of 30 to 40 for a considerable length of time, let alone a triple-digit figure.
Even if Palantir were to meet Wall Street's consensus forecast, which calls for cumulative sales growth of 132% from 2024 ($2.87 billion, actual) to 2027 ($6.65 billion, estimated), it would still be valued at a well-above-average multiple of 20 times sales in 2027 at $55 per share.
Though it's impossible to pinpoint when the music will slow or stop for Palantir, history couldn't be clearer that a big-time decline is in order.
