One stock that has massively outperformed the market this year is data analytics software company Palantir (NASDAQ: PLTR). As of market close on April 21, shares were up 20% year to date. This compares to a more than 12% decline for the S&P 500 over this same period. Even more, this is on top of an incredible 340% gain for the stock in 2024.
Many investors watching the tech stock are likely wondering if it's too late to get in on this growth story. After all, even though shares are up year to date, the stock is down substantially from recent highs. Specifically, shares are down about 28% from a 52-week high of $125.41 achieved earlier this year. Is this a buy-the-dip opportunity? And, if not, at what price would the stock look like a good investment?
Tapping into artificial intelligence hype
Artificial intelligence (AI) has been an important investing theme for some time now as businesses ramp up their investments in the space in order to stay competitive in a rapidly changing technological landscape. As a provider of a data analytics platform that utilizes AI, Palantir has benefited from this.
"Our business results continue to astound, demonstrating our deepening position at the center of the AI revolution," said Palantir CEO Alex Karp in the company's fourth-quarter earnings release. "Our early insights surrounding the commoditization of large language models have evolved from theory to fact."
With AI built deeply into its software platform, the company's total fourth-quarter revenue rose 36% year over year to $828 million. Growth was particularly strong in the U.S., where revenue rose 52% year over year.
The best part? Palantir's business generates significant cash flow. For instance, the company generated $1.15 billion in cash from operations on revenue of about $2.87 billion in 2024.
Looking ahead, management expects more impressive growth. The company guided for total 2025 revenue to increase 30.5% to 31% year over year. In addition, management said it expected its adjusted operating income to be between approximately $1.55 billion and $1.57 billion. This compares to adjusted operating income of about $1.3 billion in 2024.
Shares look overheated
But here's where a prospective Palantir investor might go from interested to skeptical: valuation. The stock's current market capitalization of about $213 billion leaves virtually no wiggle room for error.
Consider that Palantir's total GAAP earnings per share for 2024 was just $0.19. This puts the stock's price-to-earnings ratio at a jaw-dropping 474. But given that this is a company in its early innings of growth and is investing aggressively in its growth opportunities, a better valuation metric may be price-to-sales. But even Palantir's price-to-sales ratio is difficult to comprehend.
It seems like the same hype that has driven businesses to aggressively invest in AI at incredible speed has carried over to Wall Street. Investor sentiment for AI is extremely high. Palantir, with its impressive top-line growth and cash generation, has been caught up in this hype, and the stock has soared far beyond rational levels. What is the stock's price-to-sales ratio today? 78.
So, at what price would Palantir shares look attractive? Given the fast-changing and disruptive nature of artificial intelligence, investors can't count out the idea of Palantir being disrupted in the future -- just as it has disrupted other tech companies. For this reason, investors should demand a valuation that bakes in significant uncertainty. Of course, investors also need to be willing to pay up for the company's extraordinary growth. Putting these two contradicting ideas together, a reasonable valuation to consider buying a stock like this could be about 25 times sales -- a huge valuation premium over a more established software company like Microsoft, but far below Palantir stock's valuation today.
This means shares would need to lose about two-thirds of their value, falling to somewhere around $30.50, before I'd even consider buying them.
I'm sure that Palantir bulls would vehemently disagree with my analysis. They would probably say I lack vision or that I don't understand the company. Both of these statements might be true. But I'd rather put my money somewhere where I feel like I'm investing instead of speculating.
Sure, it's possible that a stock like Palantir lives up to even a speculative valuation. But history is littered with examples of tech stocks that became overvalued and subsequently delivered poor returns to shareholders for years after the momentum cooled. While Palantir's business will likely keep doing well, investors should think twice before they bet on the stock at its current level.
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Daniel Sparks or his clients have no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Palantir Technologies. The Motley Fool has a disclosure policy.
