2 reasons I’m avoiding this skyrocketing S&P 500 stock
Palantir Technologies (NASDAQ:PLTR) isn’t your average company. When it joined the S&P 500 last year, CEO Alex Karp said: “They do not comprehend how we could have turned a switch and gone…from what…professional managers and some analysts thought was a Frankenstein monster powered by a freak show leader — me — to a dynamic, clearly profitable company worthy of and admitted to the S&P 500.”
The share price returns aren’t normal either — up roughly 1,800% in just under five years! That means anyone who put £5,000 into the stock at IPO in 2020 would now have over £90,000.
The stock really took off in mid-2023 when investors realised that Palantir was about to benefit massively from helping organisations leverage AI.
In the most recent quarter (Q2), the firm’s revenue rocketed 48% to more than $1bn. And looking ahead, management is targeting a tenfold increase in revenue from last year’s $2.9bn. Impressive stuff.
So, why am I avoiding the stock? Here are two reasons.
Mainly a US AI revolution
In Q2, US revenue jumped 68% year on year and 17% quarter over quarter. This included a 53% increase in US government revenue and an eye-popping 93% surge in US commercial revenue. Customers are flocking to its Artificial Intelligence Platform.
However, as Karp repeatedly reminds us and these numbers show, this is a US-led AI revolution. International revenue growth is far less explosive. Indeed, the outspoken CEO often laments what he sees as Europe’s lack of ambition on this front.
In his Q3 2024 letter to shareholders, he wrote: “As America once again forges ahead, our allies and partners in Europe are being left behindâ¦.while the relentless innovation of US companies disrupts and reshapes global industries. Europe must adapt to the opportunities and challenges of AI, or risk ruin.”
Of course, European defence spending is set to ramp up, so there should be a lot of contract opportunities for Palantir. And just yesterday (18 September), it was announced the software firm will invest up to £1.5bn to help make the UK a defence innovation leader.
Defence Secretary John Healey said: “By harnessing the power of AI, we will boost the effectiveness of our Armed Forces.” London will become the base for Palantir’s European defence business.
Nevertheless, it’s likely to remain reliant on the US commercial sector for its strong ongoing revenue growth. Were the American economy to dip into recession, enterprises could cut back on their AI investments, slowing Palantir’s rapid growth.
Valuation
The second (main) reason I’m not going to buy the stock is because I think it’s very overvalued right now.
It’s trading at 130 times sales and 204 times forward earnings. In other words, investors are paying $130 for every $1 of revenue, and a very steep premium for expected earnings.
Palantir believes it will become “the dominant software company of the future“. The problem is that the market is already pricing this in, leaving little room for error if this doesn’t actually happen.
It can be very risky to overpay for a stock, no matter how world-class the company is. Palantir is a company that I would be interested in, but not at today’s price of $177 per share.
All told, I reckon there are other growth stocks that are better value for my portfolio today.
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Ben McPoland has no position in any of the shares mentioned. 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.
