Big data and artificial intelligence (AI) specialist Palantir Technologies(NYSE: PLTR) is somewhat of an enigma. Despite selling its software to some of the largest enterprises in the world, including several U.S. government agencies, the company has been at the center of several different movements.
A couple of years ago, Palantir briefly became a meme stock thanks to a loyal social media following as well as strong support from Ark Invest CEO Cathie Wood. More recently, the company was the focus of a report published in June suggesting people short the stock, yet it was hailed as the "Messi of AI" (a reference to the Argentinian soccer star who is considered one of the best to play the game) by tech analyst Dan Ives not long thereafter. Given the stock's 136% run-up year to date, Investors are likely assessing whether they should take some gains or add to their position.
I've written extensively about Palantir, its AI capabilities, and my long-term thesis for the stock. But instead of reviewing the company's financials and outlook, I am going to focus solely on valuation in this one.
Where does the market value the stock?
When it comes to valuation, there are a number of metrics that factor into its determination. While the capital markets can help paint a picture of where a stock was valued versus where it's valued today, there is a lot of arduous work that goes into determining whether a stock might be undervalued or overvalued.
Investors may not be surprised to learn that Big Tech names such as Microsoft, Alphabet, Amazon, Oracle, and Salesforce, for example, are all aggressively investing in AI technology. However, each of these companies could be considered a diversified conglomerate. More specifically, these companies operate in sectors such as gaming, e-commerce, and advertising, among others, in addition to areas such as generative AI and machine learning. For this reason, I've decided to benchmark Palantir against a closer cohort of big data analytics growth stocks.
Given the impact of high interest rates and their effects on profitability and free cash flow, the disparity among these companies can be tough to digest; therefore, I am comparing the price-to-sales (P/S) ratio among several companies in the chart above.
While Snowflake and MongoDB trade at meaningful premiums to rest of the field, Palantir trades in line with Datadog, and ServiceNow is not too far behind. All of these companies are investing heavily in AI, and it's interesting to see which names are garnering more support from the markets.
To me, upon looking at the analysis above, the more interesting takeaway is that Palantir essentially sits right in the middle of this cohort. But as a longtime Palantir bull, I know there is far more to the story. In the next section, I'll dig into whether Wall Street sees potential for Palantir.
What is Wall Street's perspective?
One of the most media-centric research analysts on Wall Street is Dan Ives of Wedbush Securities. Ives is a frequent guest on CNBC and often speaks about broader trends in the technology space. He recently issued a report on Palantir, comparing the company to Lionel Messi, one of the best soccer players of all time.
In sports, the all-time greats are often referred to as GOATs (greatest of all time). By calling Palantir the Messi of AI, Ives is not-so-subtly describing how advanced he believes the company's technology and capabilities are.
While I like the analogy on the surface, it's hard to back it up when looking at Ives' report. My fellow Motley Fool Neil Rozenbaum posted a video reviewing the research published by Wedbush shortly after it came out.
To summarize, Ives estimates that Palantir will reach $5 billion in revenue by fiscal 2027, and he uses a 10x multiple to derive a $25 price target. Although the forecast of a more than 60% upside from Palantir's current trading levels can be tempting, Rosenbaum makes a great point that the report lacks details supporting these future profitability estimates. In other words, while $5 billion in sales by 2027 is impressive, what is the opportunity cost?
More recently, Morgan Stanley downgraded Palantir stock to $8, which implies a 40% drop from current trading levels. According to several public reports, the bank's downgrade anchors on the gap between Palantir's AI progress and how much it is moving the needle for the company.
This is an interesting stance because Palantir's management has highlighted how much demand the company is experiencing from its AI products. For example, per the company's most recent shareholder letter, investors learned that the company's latest AI development has been deployed across 100 organizations, and the company's current pipeline has 300 or more identified opportunities. But Morgan Stanley could have a point here. Despite the impressive stats above, Palantir is only guiding toward approximately 16% top-line growth this year, far less than other notable beneficiaries of the AI boom such as Nvidia.
Although it would be nice to see a more pronounced reflection of AI demand in Palantir's financials, my view is that Morgan Stanley's stance is a bit shortsighted. Some companies, like Nvidia, will witness a higher surge in demand sooner than others due to how heavily its customers rely on its chip products. However, a company like Palantir is in a more unique position.
While the company sells its software across a variety of industries and end-markets, investors should understand a couple of nuances. First, the sales cycle for enterprise software can be quite long. It could easily take weeks or even months of demoing the products before a formal deal is put in place. Moreover, while the notion of digital transformation and where AI sits in that equation is increasingly becoming a top priority for executives, that does not necessarily mean that all potential customers currently have an identified use case in which AI is ready to be deployed.
Should you buy the stock?
The approach to investing in Palantir looks a little cloudy. Some analysts argue in favor of the company's progress in AI, while others think investors deserve to see more concrete financial results before buying. Given the number of AI-focused companies out there operating across myriad sectors, there will be no shortage of enterprise AI solutions. This is why I view putting a value on Palantir's AI potential as an exercise in false precision. AI is in such early days that it's almost misleading to assess the value of that part of the company's business.
What investors do know is that big tech is investing aggressively in AI, and this should lead to increased competition in a relatively short time. Investors could know within the next couple of years whether or not Palantir is emerging as a leader in the space and deserving of a higher trading premium.
If you invested in Palantir stock earlier this year when it was trading around its lows, it's probably not a bad idea to take some gains and recoup your initial investment, given how much the stock has run up. However, as a long-term investor, my suggestion would be to hang on to the bulk of your position. Taking short-term profits at the expense of long-term gains is not a strategy that I suggest.
As of now, the initial demand around Palantir's AI suite is encouraging, but I think investors have yet to see the full potential and impact this can have on its financial profile. For this reason, I do not think the AI hype is fully reflected in Palantir stock, despite its somewhat rich valuation when compared to other competitors.
While Morgan Stanley's research suggests a more conservative price target, I don't believe that waiting around for a massive pullback is prudent. My suggestion would be dollar-cost averaging into Palantir over time and remaining vigilant around the company's growth prospects.
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Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. John Mackey, former CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Adam Spatacco has positions in Alphabet, Amazon.com, Microsoft, Nvidia, and Palantir Technologies. The Motley Fool has positions in and recommends Alphabet, Amazon.com, Datadog, Microsoft, MongoDB, Nvidia, Oracle, Palantir Technologies, Salesforce, ServiceNow, and Snowflake. The Motley Fool recommends C3.ai. The Motley Fool has a disclosure policy.