It is often said that the stock market can stay irrational longer than you can say solvent. This axiom is relevant for investors who are short-selling Palantir Technologies (PLTR 1.44%). With shares up by a jaw-dropping 1,740% over the last five years, the artificial intelligence (AI) data analytics company has consistently proven the naysayers wrong as it pushes to new highs.
But with shares already trading at an abnormally high valuation, how much longer can the bull run last? Let's dig deeper into the pros and cons of Palantir to decide what the next three years might have in store.
Palantir's business is booming
Since its founding in 2003, Palantir's business model has involved providing big data analytics software as a service to public and private sector clients. The arrival of generative artificial intelligence in late 2022 dramatically boosted the capabilities of its tools by making the software easier to use and enabling real-time insights in fast-paced scenarios like battlefields and law enforcement operations.
The incorporation of AI seems to have supercharged Palantir's growth, as evidenced by its impressive second-quarter earnings. Total revenue jumped 48% year over year to $1 billion, driven by a 93% surge in U.S. commercial revenue as private enterprises add its tools to their operations. More importantly, the company is now generating impressive profits, with net income jumping 144% to $328.6 million.
That said, a great company isn't always a good investment if too much hype and high expectations are built into its valuation. And unfortunately, calling Palantir "priced for perfection" seems to be an understatement.
The stock faces massive overvaluation
Investors often value stocks based on earnings per share (EPS), which is the amount of profit attributed to each unit of stock. For Palantir, the picture is grim. With a price-to-earnings (P/E) multiple of 623, shares are much more expensive than the Nasdaq-100 average of 33. It even trounces AI leader Nvidia, which has a relatively modest P/E of 54.
To be fair, some of this price can be attributed to Palantir's rapid profit growth. And if you look at the stock's forward price-to-earnings ratio (which is based on projected future EPS), its valuation drops to 217. But this is still high, which implies that investors expect the stock to continue growing at an elevated rate far into the future. And this isn't guaranteed.
Image source: Getty Images.
For starters, Palantir isn't the only company offering AI-driven data analytics -- rivals like Microsoft and Snowflake offer competing software. And over time, these companies could chip away at Palantir's growth potential, especially among private sector clients, where its economic moat seems to be much weaker than with military clients. Palantir's moat comes from things like trust, switching costs, and security clearances, which are less established in the private sector.
Palantir also faced challenges related to its military work, where it is helping modernize communications systems with a new platform called NGC2 alongside another contractor called Anduril.
According to an internal U.S. Army memo cited by Reuters, the new systems are filled with "fundamental security problems and vulnerabilities," raising questions about whether the technologies Palantir is pioneering are actually ready for prime time. Nevertheless, a Palantir spokesperson claims no vulnerabilities were found in the Palantir platform, while Anduril claims that the concerns have already been addressed as part of the normal process of development.
Where will Palantir stock be in three years?
Palantir's stock is already priced for perfection, and it is hard to see it posting significant growth over the next three years. While the company's operations are firing on all cylinders, the stock won't look like an attractive long-term investment unless there is a substantial correction.
