Palantir’s price far exceeded each analyst’s target.
Over the past three months, few stocks have been better to own than Palantir (PLTR -2.50%). The stock price has more than doubled during this time, far outperforming the index and other market leaders. This performance can be attributed to several events, including Palantir’s inclusion in the S&P 500 in September and explosive third-quarter profit growth.
But the biggest reason Palantir is soaring is that many artificial intelligence (AI) investors are flocking to what they see as a software version of Nvidia, which has been a leader on the hardware side of AI investing. However, Wall Street analysts are not as enthusiastic about the stock as other investors, as the current average one-year price target of 22 analysts is $36.70, according to the Wall Street Journal.
This represents a drop of nearly 40% from today’s price, and there is a clear disconnect between what analysts think and how the stock is valued by the market. Is this a red flag that investors should be aware of, or are the analysts wrong?
Palantir’s U.S. growth boosts stock price
Palantir has made a name for itself by providing purpose-built AI models for its customers. It started with efforts in the government sector, but eventually expanded into the commercial side. As of the third quarter, government revenues remained larger than commercial revenues, with government revenues accounting for 56% of the total.
Palantir is a global company, and its software is deployed by governments and businesses alike around the world. But most of that growth comes from U.S. sources.
Sector US Growth Rate Total Growth US Revenue Share Commercial 54% 27% 57% Government 40% 33% 78%
Data source: Palantir.
These are impressive growth rates, giving bullish investors some confidence that the U.S. momentum could spill over overseas and boost earnings growth worldwide.
Additionally, Palantir is growing responsibly, rather than following a growth-at-all-costs strategy. Profit margins continued to be stable in the third quarter, a great sign that Palantir’s management is focused on profitability.
PLTR Profit Margin (Quarterly) Data by YCharts
But as good as these results may be, the biggest problem is that the fundamentals of Palantir’s business are such that many investors and analysts (including myself) don’t think it can. The question is whether it can match the expectations built into the stock price.
Stocks have unrealistic expectations imprinted on them
The problem with comparing Palantir and Nvidia is that Palantir hasn’t had the growth that Nvidia has. While 30% year-over-year revenue growth across the company is impressive, it’s a far cry from the numbers Nvidia provided investors when it tripled its revenue in multiple quarters.
I doubt that will ever happen, as Palantir’s software has far more competition than Nvidia’s. Palantir works with companies that can build AI solutions in-house, with consulting firms that already have deep relationships with clients and the software engineering talent developing these solutions, and with pre-built solutions that address a wide range of use cases. competing with other companies.
Additionally, Palantir will never be a product that small businesses can purchase. You can see that there are only 321 commercial customers in the US, with an average annual spend of $2.23 million. Because there is no vast list of companies that can spend more than $2 million a year on a particular piece of software, Palantir’s products will ultimately be limited to a specific class of businesses that can afford it. Masu.
Finally, Palantir’s valuation is spiraling out of control. After the recent post-earnings rally, the stock currently trades at 53x.
PLTR PS Ratio Data by YCharts
At a valuation of 53 times P/E, the stock is extremely expensive. This is an unrealistic valuation that will likely spell disaster for the stock in the long run.
Assume that if Palantir were to fully mature, its price-to-earnings ratio would be 45. Additionally, if we were able to achieve 30% profit margins (like other large software companies), we would need to maintain our current 30% revenue growth rate for the next five years.
Keep in mind that this only covers the breakeven point of the stock price. For stocks to outpace the market, they need to grow even faster.
Even if Palantir does well over the same period of time, I don’t think it can sustain that momentum for five years.
Palantir is a great company that is leading the way in the AI space, but the expectations are so high that I think investors should avoid the stock and move on to other investments.
Keithen Drury has no position in any stocks mentioned. The Motley Fool has positions in and recommends Nvidia and Palantir Technologies. The Motley Fool has a disclosure policy.
