After a recent analyst downgrade, shares of Palantir Technologies (NYSE: PLTR) experienced a decline of over 6%. Analyst Brian White from Monness, Crespi, Hardt & Co. shifted his rating on the stock from neutral to sell, suggesting that Palantir might face a reality check after its remarkable surge over the past year.
With Palantir’s stock soaring by 185% in the last year, driven by its growing prominence in the artificial intelligence (AI) software market, White’s price target of $20 implies a potential 13% drop from current levels due to its lofty valuation. The question arises: is this downgrade a signal for investors to sell, or could the recent pullback present an opportunity for savvy investors to consider buying Palantir shares? Let’s delve deeper to find out.
Palantir Technologies is indeed expensive right now
White highlights the “unprecedented generative AI hype cycle” as a key factor propelling Palantir stock to what he deems “an egregiously rich valuation.” A deeper examination of the company’s multiples supports this assertion.
Currently, Palantir boasts a price-to-sales ratio of 24.6 and trades at an astonishing 264 times trailing earnings. These multiples significantly surpass those of the Nasdaq-100 Technology Sector index, which stands at 7.3 for sales and 47 for earnings.
Furthermore, it’s important to note that Palantir’s growth trajectory hasn’t been as robust as some other AI-focused stocks. While the company saw a modest 17% increase in revenue in 2023 compared to the previous year, its full-year earnings quadrupled year-over-year, reaching $0.25 per share in 2023 from $0.06 per share in 2022, primarily fueled by substantial improvements in its margin profile.
During Palantir’s February earnings conference call, CEO Alex Karp emphasized the company’s “strong unit economics,” indicating that it’s generating increased revenue from each acquired customer. While Palantir’s top-line growth may not presently justify its sales multiple, its impressive earnings growth is noteworthy.
Consensus estimates suggest that Palantir could sustain remarkable earnings growth over the long term, with an anticipated annual rate of 85% for the next five years. If Palantir maintains this pace, it may be able to rationalize its rich valuation. For instance, applying the projected earnings growth rate to its 2023 earnings indicates a potential increase to $5.42 per share by the end of 2028.
Comparatively, the Nasdaq-100 boasts an average forward earnings multiple of 28. Assuming Palantir trades at a similar multiple after five years and achieves the projected earnings, its stock price could surge to $150 per share. This significant growth outlook, as anticipated by analysts, elucidates why Palantir’s forward earnings multiples appear comparatively lower.
For Palantir stock to sustain its impressive rally, it must maintain a robust pace of earnings growth, which hinges on accelerating revenue growth. Encouragingly, recent quarterly results suggest that the company may experience accelerated revenue growth, primarily attributed to advancements in AI technology.
AI is accelerating Palantir’s business
For Palantir, the significance of AI transcends mere hype, as the widespread adoption of this technology is driving tangible growth for the company, as evidenced by several key metrics.
In the fourth quarter of 2023, Palantir closed an impressive 103 deals valued at $1 million or more, marking a substantial increase from the 55 such deals closed in the corresponding period the previous year. Furthermore, customers are increasingly committing to larger deals with Palantir, with the company reporting 37 deals worth at least $5 million and 21 deals worth $10 million or more in the same quarter. These figures represent significant jumps from the prior year, reflecting a notable uptick in deal activity.
The surge in deal activity is reflected in Palantir’s year-end performance obligations, which stood at $1.24 billion, marking a nearly 28% increase from the previous year. This metric, representing the total value of the company’s future contractual obligations, growing at a faster pace than Palantir’s top-line revenue, indicates strong potential for sustained long-term growth.
Palantir attributes this heightened deal activity to the growing adoption of its Artificial Intelligence Platform (AIP), which empowers customers to deploy generative AI applications tailored to their specific business contexts. With the AI software market projected to surpass $1 trillion in annual revenue by 2032, compared to $170 billion last year, Palantir stands poised for substantial growth in the foreseeable future.
What should investors do?
While it’s undeniable that Palantir’s recent rally has inflated its stock price, there’s a compelling possibility that the company could substantiate its lofty valuation through robust top- and bottom-line growth. Contrary to mere hype, AI serves as a fundamental driver of Palantir’s business, and the influx of new business opportunities could ultimately contribute to enhanced earnings growth, bolstered by an improving margin profile.
Therefore, if Palantir’s stock continues to dip following the analyst downgrade, astute investors may view this as an opportunity to accumulate shares for the long term. Positioned to emerge as a premier AI software player, Palantir appears poised for sustained growth in the AI market.
