Palantir (PLTR 4.06%) stock appeared to be in a bubble at the start of the year. The expectations were incredibly high, and the price looked to be inflated, but then a hefty sell-off centered around artificial intelligence (AI) stocks occurred, and now Palantir is down around 30% from its all-time high.
Some investors may see this decline as a sign that the stock may be ready to roar again. However, there's one metric that investors must pay attention to that says there could be more pain ahead.
Palantir's software is in huge demand
Due to its experience in the field, Palantir has become one of the hottest AI stocks on Wall Street. Palantir's AI-powered data analytics software has been around for a long time and was originally intended for government use. After seeing a commercial use case for the software, Palantir expanded its market into the public sector.
While Palantir's base product is a strong selling point, the biggest hit lately has been its Artificial Intelligence Platform (AIP). AIP allows its users to do several things, but model integration and AI agents are the two most noteworthy. By integrating various AI models throughout an employee's workflow, Palantir's clients can control what information is fed into an AI model rather than having that info imported into a third-party AI model. Additionally, users can program AI agents to do tasks that humans normally would do; this frees up employees to do work that requires more original thinking.
NASDAQ: PLTR
Key Data Points
AIP has been a huge growth driver for onboarding new clients, but it also has been a way to expand its government clients' spending.
This dual-client approach has provided Palantir with massive growth, as both sectors have ramped up their AI spend. Palantir's government revenue rose 40% year over year to $455 million in Q4, while commercial revenue grew 31% to $372 million. Palantir has been onboarding multiple new clients on the commercial side and getting government entities to expand their usage. This has provided strong growth, but the question remains: Is it enough?
The stock is still in a bubble
Stocks get into a bubble when expectations outweigh reality. After Palantir's run-up, this was absolutely the case, as the stock traded for more than 100 times sales at its peak.
PLTR PS Ratio data by YCharts
Although 74 times sales look a bit more reasonable, I think it's still far too expensive of a price to pay for the stock. To understand what kind of growth 74 times sales conveys, let's model out the best-case scenario for Palantir. I'll assume these three things:
- Revenue growth accelerates to 40% and maintains that level over the next five years.
- Profit margins rise to 30%.
- The effects of stock-based compensation are ignored.
That's a best-case scenario for the stock, as it uses a growth rate that not even management predicts. In fact, Wall Street analysts believe Palantir will grow its revenue by 32% in 2025 and 27% in 2026. Additionally, the 30% profit margin is a level that only the best software companies achieve, and Palantir's 16% margin isn't close to that level right now.
Regardless, if Palantir somehow achieves those figures, it will produce $15.4 billion in revenue and $4.6 billion in profits, a huge increase from today's $2.86 billion in revenue and $462 million in profits.
However, if you divide today's market cap by those future figures, you'll get a price-to-sales (P/S) ratio of 13.1 and a price-to-earnings (P/E) ratio of 44. I would consider those fairly average valuations for a software stock, but in order for Palantir to achieve them in five years, it would have to put up growth that no one predicts, deliver best-in-class profit margins, maintain an equal share count (which it has never done), and have the stock price stay flat.
In all reality, well over five years of growth are baked into Palantir's stock price right now, which is far too much of a premium to pay. I think it's best if investors avoid the stock, as I'd still consider it to be in a bubble. There are far better stocks to be buying in the marketwide sell-off right now, and investors should look at those before considering Palantir.
