Is the incredible valuation justified?

The year 2021 seems like a long time ago because so much has happened since then. But just three years ago, economic stimulus sent stocks to the moon, only to crash back to earth in 2022. Enthusiastic investors drove up stock valuations. For example, the popular lending platform Upstart Holdings peaked at a market cap of $32 billion and traded at a whopping 48x sales. The company is now worth $3.7 billion, with a more modest valuation of seven times sales. Upstart wasn't worth the premium; However, for some companies this is the case.

Amazon has traded at a premium valuation for decades, and investors have been richly rewarded at 7,000% over 20 years. But what about Palantir (NYSE:PLTR)? Is the premium valuation justified?

There's a lot to like

When Palantir stock traded for less than $10 per share in 2022, investors criticized the company for being unprofitable, using too much stock-based compensation and struggling to grow commercially. These concerns have been addressed. Here are the diagrams that tell the story.

Palantir reported record operating and net profits in the second quarter of 2024. As you can see below, both have been rising steadily and significantly.

Net income of $134 million resulted in an impressive margin of 20%, while operating margin was 16%, which is also solid and growing quickly.

Stock-based compensation (SBC), which dilutes existing shareholders by increasing the number of shares available, is declining. As shown below, the increase in shares outstanding has largely leveled off as SBC has declined.

The decline is even more significant when measured as a percentage of sales. SBC accounted for 20% of revenue in the last 12 months; in 2022 it was 33%.

Finally, the company's growth in commercial customers and sales is impressive. Palantir has released its artificial intelligence (AI) platform AIP and is selling it aggressively. The program aggregates data from multiple sources and allows users to use the data to make smarter decisions. For example, a distribution company that expects downtime at a location (perhaps severe weather is forecast) can use AIP to determine the best alternatives for sourcing customer products and the impact on sales and margins.

Commercial revenue reached $307 million in the second quarter, with overall year-over-year growth of 33% and 55% growth in the United States. Government revenue was also strong at $371 million, up 23%.

It's easy to understand why investors are exuberant, but has it gone too far?

Palantir investors should be careful

Palantir stock is up 520% ​​since the start of 2023, hitting an all-time high of $40 per share. Investors who bought back then are sitting on hefty profits, but new investors should be extremely cautious. The price-to-sales ratio shown below is approaching tech bubble levels in 2021 and is significantly higher than other fast-growing tech companies.

The story continues

CrowdStrike And Cloud flare are useful comparisons because they also have gross margins of over 75% and sales growth of 30% or more. They trade at 21 and 19 times sales, respectively. CrowdStrike's valuation peaked at 29 times sales before the outage.

To put it in perspective, Palantir would need to grow its 2023 revenue at the current rate of 27% through the end of 2026 before its valuation would fall to 20x revenue at the current price. Even if the company is running well and the stock market and economy remain strong, investors still have no margin of safety. If 2021 has taught us anything, it's that valuations do matter in the long run. Palantir is a great company, but the price is too high for my money.

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John Mackey, former CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Bradley Guichard has held positions at Amazon and CrowdStrike. The Motley Fool has positions in and recommends Amazon, Cloudflare, CrowdStrike, Palantir Technologies, and Upstart. The Motley Fool has a disclosure policy.

Palantir Stock: Is the Incredible Valuation Justified? was originally published by The Motley Fool