Palantir Stock Is Booming, but Here's 1 Major Reason I Wouldn't Touch It Right Now

Key Points

• Palantir's Artificial Intelligence Platform (AIP) has transformed its U.S. commercial business.

• The company is on track to more than triple its adjusted operating income to $1.9 billion in just two years.

• 10 stocks we like better than Palantir Technologies ›

There have been plenty of companies that have benefited from the artificial intelligence (AI) boom over the past few years, but you could argue Palantir (NASDAQ: PLTR) has been the torchbearer of AI stocks.

Even as Nvidia has shocked investors by growing to become the most valuable company in the world, I'm sure many would be surprised to know that Palantir has more than doubled Nvidia's returns since the beginning of 2023.

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Palantir, which builds data and analytics tools for government and corporate clients, has delivered quarter after quarter of growing revenue and profits. The results speak for themselves. However, there is one major red flag that has me steering clear of the company right now. It's well worth paying close attention to this risk before you buy the stock.

Data by YCharts.

Where Palantir's financials stand

Palantir's Artificial Intelligence Platform (AIP) has been a major reason for its recent financial success. AIP is a platform that allows organizations to run generative AI and large language models (LLMs) within their own operations, and it's been a hit for Palantir's commercial business.

In the second quarter (Q2), Palantir's U.S. revenue increased 68% year over year to $733 million, with U.S. commercial revenue being the fastest-growing segment, increasing 93% year over year to $306 million. Palantir's commercial segment still trails behind its U.S. government segment, which grew 53% to $426 million last quarter, but it's catching up with hundreds of new deals. In Q2, the company achieved its highest-ever quarter of U.S commercial total contract value of $843 million, up 222% year over year.

Arguably more impressive, however, is the growth in Palantir's operating income, which reached $269 million last quarter. Just two years ago, in Q1 2023, the company achieved its first quarter of operating profits with $4.1 million.

Data by YCharts.

On the top line, Palantir achieved its first $1 billion quarter in Q2 and has seemingly locked in consistent profitability. That's an incredible amount of financial progress in such a short period of time.

Here's why I would avoid Palantir stock right now

The biggest issue I have with Palantir is its absurdly high valuation. As of Aug. 6, the stock is trading at close to 274 times forward earnings.

To put that into perspective, the current forward price-to-earnings (P/E) ratio of the S&P 500 is around 26, and the P/E ratio of the S&P 500 tech sector is just above 38. Even Nvidia, which is growing earnings at a faster pace than Palantir, is trading at 41 times forward earnings, and that's already expensive by most standards.

Data by YCharts.

If the company's rapid revenue growth has you focused on the top line, Palantir's price-to-sales (P/S) ratio is similarly problematic. Trading at 132 times sales, the stock is 47 times more expensive than the S&P 500, and it's by far the most expensive company in the index.

Even with Palantir's recent success, there's no way to logically justify its valuation. It has become increasingly disconnected from reality, even by tech growth stock standards, which are known for stretched valuations as investors anticipate rapid earnings growth.

The high valuation doesn't make Palantir a bad stock to have in your portfolio; it just makes it a bad time to start a position in the stock. Anything less than perfect execution going forward could cause a sharp and sudden sell-off. Investors saw it happen earlier this year with the stock losing nearly a quarter of its value from Feb. 18 to Feb. 25.

It's impossible to predict how the stock will perform in the near term, so I won't recommend waiting until the stock pulls back so you can buy on the dip. But I would recommend dollar-cost averaging and gradually acquiring shares if you're a believer in Palantir's long-term potential. This could help hedge your position against any sudden drops in the stock price.

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Stefon Walters 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.