Palantir Technologies Inc. (NYSE:PLTR) is one of the most innovative companies on the market today, with its artificial intelligence and data services products transforming commercial operations as well as government and intelligence operations in the United States and other Western allies. However, the market has already fully valued the company's shares, and in my opinion, the company's valuation multiple is too high, despite a strong second quarter. There is also a consensus on Wall Street that the stock will fall over the next 12 months, and I believe that is likely.
Despite this outlook based on valuation risk, Palantir remains one of the most exciting AI stocks, and its recent partnership with Microsoft (NASDAQ:MSFT) and strong growth potential in the commercial division, backed by a clever bootcamp sales model, bode very well for the company's long-term future. I'm bullish on the stock for the long term, but am waiting for better valuation.
Palantir benefits from the strength of its proprietary technology, particularly its artificial intelligence platform, which has been a major driver of the company's growth. Additionally, the company has a range of proprietary software platforms, including Gotham, Foundry, Apollo and AIP, that provide cutting edge data integration and analytics capabilities.
AIP is particularly noteworthy because it leverages large-scale language models and connects them to an enterprise's data, logic, and action systems. It also enables the deployment of LLM and AI techniques across private networks, enhancing security and compliance in sensitive industries like defense. So far, AIP has been a significant revenue driver for Palantir's commercial performance, as evidenced by a strong 55% increase in U.S. commercial revenue in the second quarter.
Palantir has also built strong relationships with government agencies, carving out a niche for itself and earning a reputation and trust that is hard to come by. These relationships include the US Department of Defense and the CIA, which provide a steady and significant source of revenue. The high barrier of entry for AI use cases is what excites me most about Palantir. It also makes the company essential to the future of international relations, empowering the West with AI-backed security mechanisms.
In the second quarter, Palantir's number of U.S. commercial clients increased to 295, up from 161 in the same period last year. The company signed 27 contracts worth more than $10 million, approaching $1 billion in total contract value, and its annual U.S. commercial contract value increased 44% year over year and 19% quarter over quarter. The company also launched Warp Speed, an initiative aimed at revolutionizing American manufacturing and aligning with defense and reindustrialization efforts. Additionally, Palantir's net customer retention rate improved, reaching 114% in the second quarter, evidence of successful upselling and expansion within existing customer accounts.
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Despite these strong performance results and the strong secular growth prospects ahead, I believe the stock is overvalued. This is evidenced by its price-to-earnings ratio of over 180, and excluding non-recurring items, a still very high 97. Its price-to-sales multiple is also approaching 30. Very few companies in the technology industry trade at such high valuations; even notoriously high-valued Tesla (NASDAQ:TSLA) is currently trading at a cheaper multiple of around 59x earnings.
There are clearly plenty of reasons to be bullish on Palantir, but I'm not sure the high valuation is justified. My overvaluation thesis is further supported by the GF Value Line, which shows the stock is significantly overvalued.
Palantir is a transformative AI company, but its valuation is too high
Additionally, on a price-to-sales basis, Palantir's stock trades lower than NVIDIA (NASDAQ:NVDA) but higher than Amazon (NASDAQ:AMZN), C3.ai (NYSE:AI), and Tesla. This indicates the premium investors are paying, but comparing the revenue growth rates of NVIDIA and Palantir makes one question whether the stock deserves such a high valuation.
Palantir is a transformative AI company, but its valuation is too high
Palantir is a transformative AI company, but its valuation is too high
In my opinion, a fairer price-to-sales multiple for Palantir is below 20. If this multiple approaches 30, and other valuation multiples become much more expensive, the problem arises that one operational misstep, like what recently happened with highly valued CrowdStrike (NASDAQ:CRWD), could cause a significant drop in price. This is why I believe Palantir is too risky to be a large weighting in a portfolio and I do not currently own the stock based on overvaluation concerns.
Palantir is a transformative AI company, but its valuation is too high
The average Wall Street price target for Palantir suggests the stock could fall by 19%, with GuruFocus's target price even lower at $20.80.So, with earnings per share growth excluding non-recurring items projected to be 23.70% and revenue 20.40% over the next three years, based on this consensus, I would rate Palantir a Hold.
Palantir is a transformative AI company, but its valuation is too high
Despite having a strong set of products and services, the company has struggled to retain and acquire customers. This has been demonstrated by inconsistent performance in underlying growth so far, but will hopefully be rectified going forward through a module-based sales model. This should lead to more consistent growth as users are able to gradually buy into the platform rather than investing in the full platform Palantir offers from the get-go.
Additionally, Palantir's reliance on government contracts makes it vulnerable to changes in the federal budget and subject to high levels of liability during times of war, such as in Ukraine or the Middle East. This can be revenue generating, but at worst it can strain commercial revenues and put the company in a position where it must prioritize geopolitical outcomes over pure profit and revenue generation. While the company's original clients were federal agencies in the U.S. intelligence community, it has now expanded to serve both international and local governments. This can create conflicts of interest, thereby limiting its potential for exponential growth.
The data analytics and AI space is also highly competitive. Intense competition from commercial data services companies such as Databricks, Alteryx (NYSE:AYX), and Tableau could threaten Palantir's market share, especially if geopolitical risks rise during this multipolar time and Palantir begins to focus on government contracts. To mitigate this, Palantir needs to strike a careful balance between its two core segments: commercial and government. Otherwise, competitive threats could eat away at market share in one or both markets, resulting in significant losses in future revenue potential.
Despite its sky-high valuation, Palantir has the potential to maintain its high valuation if it continues to improve its AI capabilities in sensitive, high-profile use cases. I believe its recent partnership with Microsoft to integrate OpenAI services with Palantir's AI platform to enhance its analytics and AI services for classified networks within the U.S. defense and intelligence communities bodes very well for the company's long-term growth and viability. Foundry, Gotham, and AIP will be deployed on Microsoft's Azure Government and Classified Cloud, which should increase adoption of Palantir's AI solutions in the federal government sector.
In my opinion, this is just the beginning of Palantir's potentially wider integration with large technology companies, strengthening its ability to build defense and enterprise use cases for AGI and establishing an almost entirely unique and highly valuable in-house moat for Western defense and international commercial leadership.
Palantir also launched AIP Bootcamps, a strategic initiative to drive sales, especially with commercial customers. It is an intensive workshop designed to outline how organizations can integrate AI into their operations. The company has conducted over 915 bootcamps since mid-2023, which is a major contributor to the 40% year-over-year expansion in its U.S. commercial business. This has been a huge efficiency for the company in both sales and marketing spending, which should improve margins and drive top-line growth.
These are two fundamental reasons why I believe Palantir can continue to maintain a high valuation going forward. If the company launches more strategic partnerships and growth initiatives like this, I believe bullish sentiment will grow even more. Palantir is still considered a young company, despite its high market cap of $68 billion. As its capabilities in AI defense and high-profile, sensitive commercial applications expand, it is conceivable that the company could become one of the larger technology companies. As a result, there may be short-term volatility related to valuation, but I still believe it is possible to buy Palantir now and hold it for 10 years or more and generate significant alpha.
Palantir is currently overvalued in the near term, even though it is a great company with strong fundamental growth potential over the long term if it can strategically and carefully manage its contracts and time across commercial and government customers. We believe valuation will likely cause the stock to decline over the next 12 months.
As a result of my valuation analysis, I consider Palantir a Hold and would not buy at present, but may buy in the future if the price-to-sales and price-to-earnings ratios become more reasonable. Despite this outlook, the company's partnership with Microsoft and bootcamp growth strategy bode well for the long term. If the company can further work on building a similar defensive wall over the next 5 to 10 years, I believe a buy now and hold for 10+ years could generate alpha.
This article was originally published on GuruFocus.
