Is Palantir Overvalued?

Palantir (NYSE:PLTR) has been a controversial firm for several years. Trading at high valuation multiples and often ending up at the center of major disputes over data use and surveillance, the company has divided investors and been difficult to predict.

Following a recent run-up, is Palantir overvalued now, or does the stock have the potential to justify its high price and deliver multiyear returns for shareholders?

Solid Profitability & Good Revenue Growth Bode Well

Palantir has the advantage of already being respectably profitable, a fact which sets it apart from several other high-growth tech startups. Over the past 12 months, the company’s net margin has been 9.4%, resulting in net income of $209.8 million on revenue of $2.23 billion.

Palantir also has a good history of revenue growth. Since going public in 2020, the company has reported higher revenues in every quarter.

Revenue growth has consistently been in double-digit territory. Because the company already maintains a fairly strong net margin, future revenue growth is likely to have a significant upward pull on earnings.

Both of these trends continued in the company’s most recent earnings report. In Q4, revenues climbed by 20% year-over-year to reach $608 million. GAAP net income also rose to $93 million, representing a 15% net margin.

Looking forward, it’s probable that the trends of strong revenue and earnings growth will continue more or less uninterrupted. Analysts project an earnings growth rate of over 40% in the coming 3-5 year period, while revenues are expected to increase by about 19.2% in the upcoming year alone.

Valuation Metrics Are Elevated

While fast-growing companies can support higher valuations than established ones, Palantir currently trades at multiples that will likely be difficult for most investors to get behind. Shares are priced at 23.4x sales. Even with strong revenue growth likely to carry on into the foreseeable future, this multiple is excessive in the eyes of many close observers.

Just as concerning is the combination of a forward P/E ratio of 71.5x in conjunction with a price-to-earnings-growth ratio of 2.7. While high-growth tech stocks can sometimes justify very high earnings multiples, they must be able to grow their earnings fast enough for investors to pay high premiums.

When this metric exceeds 2.0, a stock is generally assumed to be substantially overvalued. In Palantir’s case, it is at levels that even many growth investors would shy away from.

Analysts See Palantir Tumbling

Even in a market environment marked by extreme AI enthusiasm, analysts have developed a somewhat bearish take on Palantir.

The median target price for the stock over the forward 12-month period is $21, reflecting a 10.6% drop from the most recent close of $23.49.

In addition, while the largest chunk of analyst ratings suggest holding Palantir, the stock currently has more sell ratings than buy ratings.

For such a large and prominent company, Palantir also maintains a relatively low institutional ownership level. With under 35% of outstanding shares owned by institutional investors, Wall Street hasn’t demonstrated a particularly strong appetite for PLTR. As such, retail investors may also want to be cautious when looking at the stock.

50% Of Palantir Contracts Stem From 1 Source

One of Palantir’s strengths is also among its greatest weaknesses. Government contracts give Palantir a stable, reliable base of revenue that is likely to continue under virtually all macroeconomic conditions.

The problem, however, is that well over 50% of the company’s revenues come from government contracts. This creates substantial concentration risk.

Given the controversial nature of surveillance and AI technologies and the rate at which the technology is evolving, it’s far from impossible that Palantir would experience a disruption in its existing government contracts at some point in the future.

Management’s increasing focus on the commercial sector is both required and a source of shareholder optimism of late. Commercial revenue by grew 32% year-over-year in Q4.

Investors may need to see more long-term growth in Palantir’s commercial business to fully blunt the risk of dependence on government money, though.

Another risk to Palantir is that of competition from other AI-focused tech firms. With the explosion of generative AI over the past year, top companies like Amazon, Alphabet, Microsoft and IBM have all jumped headfirst into the AI industry.

Though these companies may not have Palantir’s pull when it comes to acquiring government deals, they may very well pose threats to commercial traction. As such, Palantir may have to try to compete with much larger, much more established companies as it attempts to expand its commercial portfolio.

Is Palantir Overvalued?

Palantir is 14.8% overvalued according to the consensus estimate of 17 analysts, who rate fair value at $20.02 per share.

In many respects, Palantir is a company that has a great deal to offer investors. Strong earnings and revenue growth, a lack of debt and a slew of reliable contracts all bode well for the company.

While it certainly faces its share of risks, tailwinds in the generative AI market are likely to prove strong enough to keep the company on a strong growth trajectory for quite some time.

Digging into valuation more, the multiples to sales, earnings and growth are extremely high, and the stock’s current price doesn’t seem to factor in anything below a best-case performance scenario.

Given existing concerns and the fact that Palantir is operating in a burgeoning and highly dynamic market, Palantir has virtually no room to underperform the market’s high expectations.

In the short-term, Palantir poses risks to shareholders given the reward to risk ratio may be skewed bearish. Investors who already hold shares with a lower cost basis will likely do well to continue holding given the promising long-term prospects. 

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The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.