Should You Sell Palantir Stock After Its Post-Earnings Pop? The Answer May Surprise You.

Key Points

• Palantir's business keeps getting better.

• It trades at a premium to even the most premiumly valued software companies.

• The share price is likely to underperform the indexes moving forward.

• 10 stocks we like better than Palantir Technologies ›

Palantir Technologies (NASDAQ: PLTR) stock impressed investors yet again with its latest quarterly results. Revenue growth accelerated and profit margins expanded all while the company signed larger and larger deals with customers.

The stock is up 28% in the last month. It is up close to 600% in the last year. The software provider has produced phenomenal gains for shareholders and is now one of the most valuable companies in the world with a market cap surpassing $400 billion.

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But now, with this earnings pop behind us, is it finally time to sell your Palantir shares? Or are there more gains to be had for long-term shareholders? The answer is clear when you dig into the numbers.

Image source: Getty Images.

An incredible business journey

The reason for Palantir's stock price appreciation is a miraculous comeback in its growth. In 2023, the company's revenue growth had slowed to around 12% year over year, even though it was barely generating $2 billion in revenue. Selling analytics and monitoring software is not a limitless addressable market, but Palantir clearly had a lot more potential if it could execute.

Then, the artificial intelligence (AI) revolution began. Palantir was perfectly preparing for the present moment with its AI-focused software, which has led to steady acceleration in revenue growth at greater scale. Last quarter, revenue grew 48% year over year and hit an annualized run rate of $4 billion, Profit margins have also shown steady progress, hitting 27% last quarter when the company was unprofitable just a few years ago.

A turnaround such as this is why Palantir shares are up 600% in the last year. It has reaccelerated revenue growth and looks to be building huge momentum with contract wins at businesses and the United States government. Last quarter alone, it closed 42 deals worth $10 million or more. This should lead to strong future revenue growth in the next few years.

Putting the valuation in context

After this recent run, Palantir now has a market cap of $425 billion. That makes it the 22nd most valuable company in the world by market capitalization. And yet, it has only hit a run rate of $4 billion in annual revenue.

This puts Palantir's valuation at the extreme level, even for fast-growing software businesses. For context, one stock with a premium valuation in software is Shopify, and it has a price-to-sales ratio (P/S) of just over 20. Palantir's is 132. This gap -- where Palantir is valued at 5x or even more than a group of software stocks already with premium valuations -- should be front of mind for investors.

Even though Palantir has fantastic profit margins that may grow even more in the coming years, there is only so much margin expansion you can achieve. Profits cannot be higher than revenue, and Palantir is valued at an extreme level of revenue at the moment. The stock's only path forward to meet these high expectations are many years of strong double-digit revenue growth close to the levels it is at today.

PLTR PS Ratio data by YCharts

Should you sell Palantir stock?

I believe it is possible that Palantir can keep up its revenue growth of approximately 50% for the next few years. Its United States commercial revenue is growing at 93% year over year, which is propelling consolidated revenue to keep accelerating.

However, eventually you run out of enterprises and government agencies to sell software to. Software budgets are not infinite, and growth is bound to slow down once the AI boom tempers out. This should be a warning sign for Palantir shareholders, because the stock may need a bunch of years of huge revenue growth to warrant buying the stock at its current market cap.

Even if revenue grows by 10x over the next decade, the stock will still be trading at a premium price-to-sales ratio (P/S) of above 10, and that is assuming the stock price doesn't move for a decade.

If you buy a stock, you want it to be likely that the share price will rise over a decade. Expectations are much too high on Palantir stock, and it is likely to greatly underperform the broad market indexes moving forward. It is time to sell, or at least trim, your Palantir position after this recent earnings pop.

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Brett Schafer has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Palantir Technologies and Shopify. The Motley Fool has a disclosure policy.