Palantir Stock is Skyrocketing, But is it a Buy?

$Palantir Technologies Inc.(PLTR)$ Palantir has seen extraordinary growth, up over 900% from its 2022 lows and 360% year-to-date, sparking speculation of a 100x potential that could raise its valuation to $17 trillion. While these predictions are exciting, I want to provide a grounded perspective on Palantir's valuation.

First, congratulations to those who’ve profited from Palantir's meteoric rise. It’s a remarkable company with solid fundamentals. However, it’s crucial to distinguish between the business and the stock price, as the two can often become disconnected. In this video, I’ll focus on the numbers and what they imply about the current valuation.

Recent Performance Highlights:

• Q3 2024 Revenue: $726 million, up 30% year-over-year.US Revenue: Up 44% year-over-year.US Commercial Revenue: Up 54% year-over-year.

• Free Cash Flow (FCF): $1 billion (trailing 12 months), with an adjusted FCF margin of 60% for Q3, though management guides for 40% annually.

• Customer Growth: Total customer count rose 39% year-over-year but slowed to 6% quarter-over-quarter.

• Balance Sheet: $4.6 billion in cash versus $1.2 billion in total liabilities—exceptionally strong financials.

Despite these impressive metrics, Palantir’s valuation metrics suggest the stock may be priced for perfection. The company trades at a price-to-sales ratio of 62, implying significant future growth is already factored in. Even if Palantir 5x its revenue while maintaining a 40% FCF margin, it would still trade at a 30x FCF multiple, offering a modest 3.3% yield—barely above bond yields.

Meme Stock

Palantir Technologies (PLTR) has, at times, been referred to as a "meme stock" due to its popularity among retail investors and its volatility driven by online communities such as Reddit's. PLTR is frequently mentioned in meme-stock communities, with users promoting bullish narratives or anticipating short squeezes. These campaigns have contributed to trading volume spikes and rapid price fluctuations.

The stock has experienced significant price surges unrelated to fundamental changes, driven by retail speculation and hype, including expectations about artificial intelligence (AI) and its potential role in the future economy.

Fundamental Business Model:

• Unlike traditional meme stocks, Palantir has a viable business model, recurring government and commercial revenue, and a growing presence in AI-driven solutions. This sets it apart from companies struggling with profitability or declining industries.

$Palantir Technologies Inc.(PLTR)$ Retail-driven momentum can lead to dramatic price swings, creating risks for long-term investors.

The stock Disconnect from Fundamentals may trade at prices that are not reflective of the company's intrinsic value, which can lead to corrections.

Investment risk

Dilution Risks Palantir has historically relied on significant stock-based compensation, which dilutes existing shareholders. Although the company has started to address this issue, it remains a point of caution for investors.

Customer Concentration Palantir's reliance on a small number of key clients for a substantial portion of its revenue poses a risk. Loss of any major customer could significantly impact financial performance.

Reliance on Government Contracts

A significant portion of Palantir's revenue comes from government contracts, particularly in defense and intelligence sectors. While these contracts are typically long-term, changes in government budgets or policy priorities could negatively impact Palantir's growth prospects.

Valuation Concerns

Palantir has often been criticized for its high valuation relative to its fundamentals, including earnings and revenue growth. The stock's price-to-sales ratio is elevated, making it susceptible to market corrections, especially during periods of rising interest rates or market volatility.

The Bigger Picture on Valuation:

Drawing from Warren Buffett’s philosophy, the price you pay for a business must reflect its future cash flow potential. Overpaying can lead to a prolonged period of under performance, as seen with Microsoft post-2000. Despite strong earnings growth, the stock price didn’t recover for 16 years due to an inflated valuation during the dot-com bubble.

Currently, Palantir’s market cap of $164 billion assumes extraordinary growth. A projection of 45% annual FCF growth and a 50x multiple five years from now yields a 10.3% annual return—just slightly above the S&P 500’s historical average. If growth slows to 30% annually, returns drop to 9% annually, below the historical average for high-growth companies.

Valuation Concerns

• Palantir's current valuation, with a market cap of $164 billion and a price-to-sales ratio of 62, appears inflated.

• Even with optimistic growth assumptions (e.g., 45% free cash flow growth for 5 years), projected returns barely outpace historical market averages.

• Historical Lessons: Overpaying for high-growth businesses (e.g., Microsoft in 1999) can lead to decades of stagnant returns, despite business growth.

Key Takeaways

• The stock price and business fundamentals can disconnect. Palantir is a high-quality business, but its stock price reflects excessive optimism.

• Current market behavior resembles past speculative frenzies, where price appreciation outweighed fundamentals.

• Investors should focus on fair valuation to avoid long periods of under performance, even with strong business growth.

Technical Analysis

Palantir Technologies (PLTR) has seen significant interest from short sellers in recent months, with its short interest rate varying over time. As of late 2024, short interest in PLTR stock has been relatively moderate, fluctuating between 13% and 25%, suggesting mixed sentiment about its future price movements.

Analysts' consensus on Palantir remains divided. Some foresee potential growth driven by expanding government and commercial contracts, alongside improving profitability metrics. However, concerns about overvaluation persist, as Palantir's price has risen considerably relative to its earnings and revenue growth. The stock currently has a "Hold" consensus among analysts, with some recommending caution due to its high valuation.

Conclusion

While Palantir is a phenomenal business, its stock price reflects extreme optimism, leaving little room for error. The market is pricing in a perfect growth trajectory, but even strong companies can underperform when valuations overshoot. History reminds us that price matters. Investors should weigh the stock’s price carefully against its long-term growth potential to avoid the risks of overpaying.