Due to high demand, Palantir’s growth has accelerated.
By any reasonable standard, Palantir (PLTR -1.56%) is thriving. The company has one of the best artificial intelligence (AI) software application platforms on the market and is a top choice for integrating AI models into businesses to make decisions. This dominance has resulted in revenue growth accelerating quarter over quarter, making the stock popular with AI investors.
But there is one factor – Palantir’s high valuation – that some investors fail to consider. And investors should weigh that valuation very carefully, especially when considering a new investment in this dynamic company.
Palantir’s business is a hit
Palantir has been in the AI software market longer than many of its competitors, which is likely the reason for its success. Originally intended for government use, Palantir’s software was used by both intelligence and operational agencies to ensure decision-makers had the best information.
Eventually, management realized that the software would have uses outside of the government sector, so it expanded its reach to the civilian sector. While government revenue still accounts for more than half of Palantir’s total revenue, the commercial side of the business is growing rapidly.
Growth on the commercial side is focused on “unprecedented demand” (words of management) for its Artificial Intelligence Platform (AIP). AIP enables its customers to integrate AI (including large language models) across the enterprise, automating processes like never before and incorporating human consent when needed.
The possibilities for AIP are truly endless and growth has been impressive, especially in the US. In the second quarter, US commercial revenue was Palantir’s fastest-growing segment, up 55% year-over-year to $159 million. Still, Palantir’s other segments didn’t fare too badly: total commercial revenue was up 33% year-over-year and government revenue was up 23%. Overall, this resulted in a growth rate of 27%, continuing the trend of accelerating revenue growth.
Revenue growth is great, but accelerating revenue growth is even better. Another plus for Palantir is that it is a profitable company. In the second quarter, it posted a profit margin of 20% – a company record.
Palantir does everything it takes to be a successful company and more, so it’s no wonder many investors are excited about it.
However, the stock has an Achilles heel that everyone should know about.
Expectations for the share are extremely
Everything I wrote above is well known in the market. As a result, the stock has become incredibly expensive.
90 times forward earnings and 31 times revenue are incredibly high valuations. Although Palantir is growing rapidly, such prices are usually reserved for companies that double or triple their revenue quarter after quarter. Palantir is not doing that, which worries me.
Let’s assume Palantir’s growth rate accelerates even more to 30% year-over-year and maintains that figure for five years. That would give Palantir annual revenue of $9.2 billion by 2029. If profit margins improve to 25%, that would equate to $2.3 billion in profit.
Dividing this number by Palantir’s current market capitalization gives us the price-to-earnings ratio for 2029, which is 31 times projected earnings.
So for Palantir to return to a valuation level similar to that of other established software companies, the company needs to increase its margins to 25% and grow at a sustained 30% rate. That’s a very tall order, and I don’t think Palantir is up to it.
For this reason, I think the stock is priced way too high and will therefore avoid it. Palantir will continue to be successful as a company, but the growth expectations priced into the stock are too high for my taste.
Keithen Drury does not own any stocks mentioned. The Motley Fool owns and recommends Palantir Technologies. The Motley Fool has a disclosure policy.