Palantir Technologies (PLTR -2.81%) stock's stunning surge of 372% in 2024 has made the stock extremely expensive, which explains why investors may be wary of buying this high-flying artificial intelligence (AI) software specialist right now.
Wall Street is expecting Palantir stock to dip in the coming year, as evident from the 12-month median price target of $39, which points toward a 48% drop from current levels. According to 22 analysts that cover Palantir, this median price target suggests that the stock may have gotten ahead of itself, and that's not surprising if we take a look at its valuation multiples.
After all, a price-to-earnings ratio of 399 and a sales multiple of 72 tell us that investors will have to pay significantly rich multiples to buy this AI stock. The tech-laden Nasdaq-100 index, on the other hand, trades at 32 times earnings. However, there are a couple of reasons that Palantir may be worth buying hand over fist despite its expensive valuation.
Palantir is the leading player in a fast-growing market
Palantir's growth has accelerated in recent quarters thanks to the fast-growing demand for the company's Artificial Intelligence Platform (AIP), which allows governments and organizations to integrate generative AI into their operations. It is worth noting that this platform was ranked as the top AI/ML (machine learning) platform by market research firm Forrester last year, ahead of well-established names such as Microsoft, Amazon, and IBM, among others.
However, this wasn't the only time that Palantir has been ranked among the top vendors of AI software platforms. In September 2024, Dresner Advisory Services gave Palantir the top rating in usability and analytical features and functions in its AI, Data Science, and Machine Learning Market Study. Meanwhile, market research firm IDC ranked Palantir No. 1 in the AI software platform market back in 2021.
IDC points out that the AI software platforms market was worth an estimated $14.2 billion in 2021, growing by almost 37% that year. Palantir's revenue in 2021 stood at $1.54 billion, growing 41% during that year. However, Palantir was getting the majority of its revenue in 2021 from selling software platforms and analytics solutions to government customers.
It has only been in recent quarters that its AI business has started taking off, which is evident from the rapid growth in the company's commercial customer base. For instance, in 2021, Palantir's commercial revenue jumped 34% to $645 million, compared to the 47% growth in government revenue, which was $897 million.
Coming to Palantir's latest results for the third quarter of 2024, its commercial customer count jumped an impressive 51% year over year to 498. Given that Palantir had a total of 629 customers at the end of the quarter, it can be assumed that the company finished the quarter with 131 government customers as compared to 123 in the same quarter a year ago.
This massive jump in the commercial customer base is a result of the rapid adoption of Palantir's AIP, which has witnessed robust demand in recent quarters thanks to the company's aggressive go-to-market strategy of conducting "boot camps." Not surprisingly, Palantir now expects to report at least 50% growth in its U.S. commercial business for 2024 to $687 million. That points toward a solid jump from the 36% growth in 2023 to $457 million.
This terrific uptake of Palantir's AIP should allow it to remain one of the top players in the AI software platforms market in the long run, and that should turn out to be a solid tailwind for the company. That's because the size of the AI software platforms market is expected to hit $153 billion in 2028, as per IDC. Given that Palantir is quickly building up a big base of commercial customers, it should be able to make the most of this huge addressable opportunity and continue to deliver stronger top and bottom-line growth in the coming years.
Favorable unit economics could lead to outstanding earnings growth
Palantir's earnings are growing at a faster pace than its revenue. In the third quarter of 2024, the company's adjusted earnings increased 43% year over year to $0.10 per share as compared to the 30% increase in revenue to $726 million. This faster growth in the bottom line can be attributed to the company's ability to first land a new customer and then expand its business with those customers.
Palantir management provided a few examples of this on the November earnings conference call:
To highlight a few notable deal cycles: a large American equipment rental company expanded its work with us less than eight months after converting to an enterprise agreement, increasing the account ARR 12-fold; a bottled water manufacturer, a specialty pharmaceutical company, and an agricultural software provider, all signed seven-figure ACV deals less than two months after their initial boot camps.
This is a trend that's likely to continue thanks to the secular growth of the AI software platforms market and Palantir's AIP offering, which is considered to be superior when compared to peers. As a result, Palantir should continue to enjoy favorable unit economics as its land-and-expand strategy should allow it to generate more profit from each customer.
The effects of favorable unit economics are already visible on Palantir's margin profile. The company reported an adjusted operating margin of 38% in the third quarter of 2024, up from 29% in the year-ago period. This figure could move higher in the future and power Palantir's earnings growth, given that it has been adding new commercial customers at a rapid pace of late, and those customers could strengthen their relationships with the company to deploy generative AI solutions.
That's why it would be prudent to look past Palantir's valuation. The company is expected to deliver a 52% jump in earnings in 2024 to $0.38 per share. The estimates for 2025 and 2026 have moved significantly higher in the past few months, a trend that could continue, as the discussion above indicates.
PLTR EPS Estimates for Next Fiscal Year data by YCharts
As such, investors looking to add a growth stock to their portfolios would do well to look at the bigger picture instead of just the valuation as the multibillion-dollar opportunity in AI software platforms, Palantir's robust position in this market, and the company's efforts to make the most of this space could help it remain a top AI stock in the long run.
