Why a P/E ratio of 424 doesn’t (necessarily) make Palantir shares overvalued

Saying Palantir (NASDAQ:PLTR) shares are overvalued because the price-to-earnings (P/E) ratio is 424 is – I think – a mistake. It’s like saying someone can’t climb Everest because the mountain is big.

Someone’s ability to get to the top of Everest depends on their mountaineering skills. And the value of Palantir’s stock comes down to its future growth prospects – which I think are outstanding.

Valuation

There’s more to valuation than P/E ratios. Don’t believe me? – here’s Warren Buffett in the Berkshire Hathaway Annual Shareholder Letter from 2000:

“Common yardsticks such as dividend yield, the ratio of price to earnings or to book value have nothing to do with valuation except to the extent they provide clues to the amount and timing of cash flows into and from the underlying business.”

This isn’t to say the P/E ratio is irrelevant (in the same way the height of Everest isn’t irrelevant to the question of whether or not someone can climb it). But it isn’t the only thing that matters.

Ultimately, the value of a stock comes down to how much cash the company is going to make and when it’s going to make it. That’s as true of Palantir as it is of anything else.

The equation

Right now, Palantir has a market cap of around $190bn and a 10-year government bond comes with a yield of 4.5%. So to justify its current valuation, the business needs to make around $86bn by 2035.

That’s $8.6bn per year and the company managed just over $462m in 2024. That means there’s a lot of growing to be done, which could be inferred from the P/E ratio.

To generate $86bn by 2035, Palantir is going to have to grow its earnings by over 50% per year. Again though, this only gives an idea of the scale of the challenge.

It’s big, but it isn’t impossible. Just as an outstanding mountaineer can climb Everest, an exceptional business can achieve that growth – the question is whether or not Palantir is exceptional enough.

Palantir’s prospects

There’s a mountain to climb, but I find it hard to imagine a business with better prospects for doing it than Palantir. It provides real value to customers and a huge addressable market.

During 2024, the company signed up companies from bottled water manufacturers to insurance brokers. And in the last three months alone, it brought on another 82 new customers.

As a result, US commercial revenues grew 64% in the fourth quarter of 2024. And there’s currently no visible competitor in sight, which is why CEO Alex Karp thinks there’s decades of growth ahead.

That’s not to say there are no risks at all. The company acknowledges that the rise of artificial intelligence is likely to raise regulatory and legal challenges and investors can’t just ignore these.

Foolish takeaways

It’s not clear to me whether or not Palantir shares are good value right now and there are other opportunities where I think this is more obvious. So I’m focusing on other investments for my portfolio.

One thing I am clear on, though, is the idea that a high P/E multiple means the stock is overvalued is far too simplistic. With any shares, the question of value comes down to the underlying business.

The post Why a P/E ratio of 424 doesn’t (necessarily) make Palantir shares overvalued appeared first on The Motley Fool UK.

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Stephen Wright has positions in Berkshire Hathaway. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.