Should You Worry About Palantir's Valuation?
Key Points
Palantir stock has soared in the quadruple digits over three years.
At the same time, valuation also has surged -- and some investors consider the stock quite expensive right now.
Palantir Technologies (NASDAQ: PLTR) has had a lot going for it in recent quarters. The artificial intelligence (AI) software company has seen revenue in its commercial and government businesses climb in the double digits and has expertly balanced growth with profitability. Investors have noticed, prompting the stock to soar 1,200% over the past three years.
On top of this, with demand for its Artificial Intelligence Platform (AIP) climbing and the overall AI market marching higher toward the trillions of dollars, Palantir's future looks bright.
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But one element has cast a shadow over this sunny story, and that's the stock's valuation. This too has surged, with the stock today trading for more than 230x forward earnings estimates -- a level that some investors might consider exorbitant. Should you join that camp and worry about Palantir's valuation? Let's find out.
Image source: Getty Images.
Why is Palantir soaring?
So first, we'll talk about why Palantir has become so successful, especially in recent years. The 20-year-old company specializes in software that aggregates a customer's data and helps the customer use that data to make decisions, develop products or strategy, and more -- and the release of AIP two years ago added AI-driven data gathering and analysis, supercharging the software company's abilities.
Work with Palantir could be game-changing for a government or commercial customer, which is one of the reasons demand has taken off in recent times. For example, mining giant Rio Tinto says that, thanks to AIP, it's accessing unstructured data and therefore handling problems that it wasn't able to handle before. The general interest in AI is another reason for Palantir's growth: AIP makes it fast and easy for a customer to apply AI to its operations and see the benefits, so, with the AI market expected to reach $2 trillion in a few years, customers may continue to flock to Palantir.
The AI boom also specifically has helped Palantir's commercial growth explode higher. Traditionally, Palantir was most known for its contracts with governments -- for everything from military maneuvers to vaccine rollouts -- but in recent times, commercial companies, eager to get in on AI, have flocked to Palantir's AIP.
Two key growth drivers
All this means, today and down the road, that both the U.S. government and U.S. commercial businesses represent key growth drivers for Palantir. In the most recent quarter, their revenues rose 45% and 71%, respectively, and Palantir lifted its forecasts for revenue, adjusted income from operations, and adjusted free cash flow guidance for the full year.
The company also has been winning when it comes to ensuring both growth and profitability, with a Rule of 40 score of 83% in the quarter. If a software company achieves 40% or higher, it's seen to be doing a good job on this, so clearly Palantir is greatly excelling.
Now, let's move along to the one problem that's been keeping some investors from buying Palantir stock, and that's valuation. As mentioned, it's reached an extremely high level and has been at high levels for quite some time.
PLTR PE Ratio (Forward) data by YCharts
But it's important to remember that other tech giants also have gone through periods, often in their early growth days, of high valuations. We can see this for Amazon, Apple, and Meta Platforms in the chart. And we also can see that shares of each company have gained over time.
AMZN PE Ratio data by YCharts
So, if you refused to buy these companies because of their high valuations, you might have missed out on owning some of the world's most successful technology stocks.
And valuations don't offer us a complete picture. They reflect recent earnings or estimates for the coming year -- but they don't consider potential several years down the road.
Buying early or buying later
Of course, valuations of these tech giants eventually came down to reasonable levels, and the stocks slipped from time to time, offering investors interesting buying opportunities. It's fantastic to get in on a stock in its early days and stick around for the entire growth story, but the patterns of Amazon, Apple, and Meta show us that, generally, you also can buy a quality company at a later date and still score an investing win if you hold for the long term.
Now, let's get back to our question: Should you worry about Palantir's valuation? Not if you're a long-term investor. If you buy the stock even at today's lofty valuation, as long as Palantir continues to deliver solid earnings, you could see your investment grow significantly over time.
And if you wait to invest? Valuation may come down at a certain point, and like today's biggest tech companies, Palantir could offer gains to long-term investors -- whether they buy the stock early on or later during this growth story.
John Mackey, former CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Randi Zuckerberg, a former director of market development and spokeswoman for Facebook and sister to Meta Platforms CEO Mark Zuckerberg, is a member of The Motley Fool's board of directors. Adria Cimino has positions in Amazon. The Motley Fool has positions in and recommends Amazon, Apple, Meta Platforms, and Palantir Technologies. The Motley Fool has a disclosure policy.