Palantir (PLTR -0.59%) is one of the hottest artificial intelligence (AI) stocks out there. It has risen an astronomical 362% since the beginning of 2024 and shows little signs of slowing down. However, the consensus among Wall Street analysts is that this stock is significantly overvalued. According to Yahoo! Finance, the average price target among 22 analysts is $46.01. Compared to today's stock price of around $75, that represents a 40% downside.
Nobody wants to see their investments decline by nearly half, so understanding where these analysts are coming from is critical. It's not often that a stock is priced this much over analysts' targets.
Palantir's AI prowess has led to strong growth
Palantir has become a popular pick in the AI space because it has been in the AI game far longer than most of its competitors. It was founded in 2003 and originally provided AI software to government entities to aid in decision-making. The use case eventually expanded to commercial customers, significantly expanding its market opportunity. Government revenue still makes up the majority of Palantir's total, with Q3's revenue split being $408 million from government clients and $317 million from commercial customers.
Palantir's revenue growth has been strong, with revenue rising 30% in Q3. As another important note, Palantir is also fully profitable, boasting a solid 20% profit margin in Q3. Those are solid figures, but the issue that analysts take with Palantir's stock isn't its business opportunity or current growth, it's how much expectations are baked into Palantir's current stock price.
Palantir's expectations far exceed reality
Palantir's stock isn't cheap. It trades for a jaw-dropping 397 times trailing earnings and 138 times forward earnings.
PLTR PE Ratio data by YCharts
Those are incredibly high levels, making it difficult to justify Palantir's stock price with its current growth.
Some bulls might point out that Palantir could always expand its profit margin to bring some of those earnings-based metrics down. However, Palantir's price-to-sales (P/S) ratio of 72, compared to other software companies that aren't profitable, is still unbelievably expensive.
PLTR PS Ratio data by YCharts
Some of the highest-flying software companies trade for 20 to 30 times sales, which means Palantir is valued at over double that of those businesses. Now, this could all be justified if Palantir were growing its revenue incredibly quickly, but it's not.
To illustrate this, let's look at how much growth is priced in over a five-year period. To give Palantir the best-case scenario, let's assume these things:
- Palantir's revenue growth stays at 30% for the next five years.
- Palantir's profit margin expands to 30%.
- Share dilution due to stock-based compensation is ignored.
With that in mind, after a five-year period, Palantir will have revenue of $9.82 billion and profits of $2.95 billion. While that's a solid increase from today's $2.64 billion in revenue and $477 million in profits, it still doesn't justify the stock price.
Palantir would have a trailing price-to-earnings (P/E) ratio of 61 at those earnings levels. So, after five years of the stock price not rising, Palantir would still be more expensive than many big tech companies.
Two of those three assumptions are also poor. Wall Street analysts expect 25% revenue growth in 2025, a good amount less than the 30% sustained growth used above. Additionally, Palantir has high levels of shareholder dilution, with its share count rising 3% year over year.
It wouldn't surprise me if Palantir reaches a 30% profit margin, but that's just one of the assumptions required for Palantir to still be expensive after a five-year period.
While I don't know if Palantir stock will decline by 40% in 2025, it wouldn't surprise me if there were some selling pressure once the AI investing hype dies down. Palantir's stock is just too expensive to justify its current price tag, and I'd be selling shares now if I owned any.
