Investors Are Piling Into Palantir Stock After Revenue Soars. Should You Follow?
Palantir (NYSE: PLTR) has been one of the hottest stocks of the year, rising around 275% as of the time of writing. However, a massive chunk of that gain came right after Palantir’s blowout third-quarter earnings; the stock rose 23% the next day. But that strength has continued well past the day following earnings, as the stock is now up 56% since the company announced outstanding results on Nov. 4.
Clearly, many investors are piling into Palantir’s stock, but is that a good idea? After all, the stock has seen a massive run-up and has sky-high expectations built into it.
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Palantir is an artificial intelligence (AI) company that made a name for itself by creating custom AI models for the government. Eventually, it expanded to the commercial space. As of Q3, government business still makes up the majority of its revenue, but it’s a very close split, with government revenue making up 56%.
Palantir’s AI model gives decision-makers real-time guidance based on the data it receives. This is useful in any situation where real-time decisions must be made quickly and accurately. Considering that’s a huge chunk of what governments and businesses do, it makes sense that Palantir’s business is rapidly growing, with many clients rushing to implement AI into their systems.
Another key product Palantir has introduced is its Artificial Intelligence Platform (AIP). AIP allows its clients to integrate AI throughout a business’s inner workings, making AI a tool that isn’t just used on the side. That’s a key differentiator from many AI products available and has been a big reason for Palantir’s blowout results.
In Q3, Palantir’s revenue rose 30% year over year to $726 million. In particular, U.S. commercial revenue rose 54% year over year. Should this demand spread worldwide, it wouldn’t be out of line to see its overall revenue growth accelerate to that level.
Furthermore, Palantir isn’t a growth-at-all-costs business. It is highly profitable and delivered a 20% profit margin in Q3.
These are fantastic results that investors should cheer on. However, if the stock’s exuberance has priced in all future growth, then there’s no reason to own it moving forward. I’m worried that we’ve reached that point, as the expectations built into Palantir’s stock are quite lofty.
While 30% revenue growth is impressive, it’s not that impressive. AI leader Nvidia saw multiple quarters where its revenue growth was above 200%, and even as it’s slowing down, Nvidia is still projected to grow its revenue by about 80% next quarter.
However, Palantir is now trading at levels that Nvidia’s stock never reached.
With Palantir having a more expensive price tag than Nvidia, despite it having an order of magnitude slower revenue growth, it doesn’t pass the smell test.
Furthermore, if you consider what expectations are built into the stock now, it’s clear Palantir has gone up too far, too fast.
Let’s say the target for Palantir’s stock is to trade for 50 times trailing earnings (still a very expensive valuation). Additionally, let’s assume that Palantir maintains its 30% revenue growth and its current 20% profit margin. At that rate, it will take over six years to achieve that valuation.
That assumes two things: First, the stock price doesn’t budge from today’s prices, and second, the share count doesn’t rise. Considering that Palantir’s share count rose 3.5% over the past year, that’s a bad assumption and would further increase the amount of time it would take to achieve our target.
In reality, Palantir likely has around seven years of growth priced into the stock price already at its current growth rate and profitability level. This is a massive figure and will likely not work out well for investors. As a result, I think it’s best for investors to avoid the stock or at least trim some of their gains. Few stocks (if any) have ever traded for more than 50 times sales and worked out. If Palantir were tripling its revenue like Nvidia did in its prime, I wouldn’t have this same opinion, but 30% revenue growth just isn’t going to cut it for its current valuation.
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Keithen Drury has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Nvidia and Palantir Technologies. The Motley Fool has a disclosure policy.
Investors Are Piling Into Palantir Stock After Revenue Soars. Should You Follow? was originally published by The Motley Fool