Palantir: Irrational Exuberance, Downgrade To Sell (NYSE:PLTR)

This quarter has seen heightened volatility for software stocks as high expectations have led to swift punishment on any disappointment. Yet, Palantir (NYSE:PLTR) seems to have evaded this volatility, a curious development given that the high valuation would seem to imply high expectations. The company has continued to see acceleration in growth rates, but hardly enough to justify the stock’s lofty 25x sales multiple. The company has a net cash balance sheet and is profitable on a GAAP basis, but the high valuation makes me skeptical about the future outlook for the stock. I am now downgrading the stock to sell, as the risk-reward has skewed sharply to the downside.

PLTR Stock Price

I last covered PLTR in June, where I advised avoiding the stock due to the aggressive valuation. The stock has since roared nearly 30% higher.

The stock has come up too much and too fast, and looks particularly vulnerable amidst a shaky market.

PLTR Stock Key Metrics

PLTR is an enterprise tech firm offering data analytics products. In today’s day and age, that makes it a direct play on artificial intelligence. Like many AI plays not named Nvidia (NVDA), the company has seen a delayed start to the promised acceleration in growth due to AI. In the latest quarter, however, PLTR has broken away from the pack and has shown continued strength even while most tech peers are showing weakness.

PLTR delivered 27% YoY revenue growth to $678 million, crushing guidance of between $649 million and $653 million. That 27% growth rate marks the 4th consecutive quarter of sequential acceleration in revenue growth since growth plateaued in the second quarter of last year.

PLTR saw its customer count outpace top-line growth at 41% YoY. Bulls might point to the potential for these customers to continue powering strong growth rates as they begin to ramp up their spending on the platform.

The company saw particular strength in its commercial business, with commercial revenues growing 33% YoY to $307 million and US commercial revenues growing 55% YoY to $159 million.

The company notably saw US commercial customers grow 83% YoY, again potentially indicating continued strong growth moving forward.

The company saw remaining performance obligations (‘RPOs’) grow 41% YoY to $1.37 billion, including short-term RPOs grow 23% YoY. Billings grew 19% YoY. Some investors view RPO growth (especially cRPO growth) as a potential leading indicator of future revenue growth, but this metric may be sending mixed signals relative to the aggressive customer count growth.

The company’s government business is often viewed negatively by investors due to its slower growth, but this segment saw growth accelerate to 23% YoY.

The company remained highly profitable, with adjusted operating income growing 88% YoY to $254 million, exceeding guidance of between $209 million and $213 million.

It is worth noting that PLTR is also solidly profitable on a GAAP basis, generating $134 million in GAAP net income in the past quarter alone.

PLTR ended the quarter with $4 billion of cash versus no debt, representing a pristine net cash balance sheet. Between the GAAP profitability and strong balance sheet, PLTR has a bulletproof financial profile.

Looking ahead, management has guided for the third quarter to see revenue growth of up to 25% to $701 million. Management also raised full-year revenue guidance from $2.689 billion to $2.75 billion at the high end, as well as profits from $880 million to $974 million. Most enterprise tech firms in my coverage universe struggled to reiterate full-year guidance and even tempered expectations – but PLTR delivered a significant beat and raise.

On the conference call, management again reiterated their optimism for ongoing momentum due to their bootcamp efforts. Management highlighted the “immense challenge of deploying enterprise production AI software at scale” and at this point, I’d bet that many investors are believing that notion given the tempered growth that we have seen at names like MongoDB (MDB) and Snowflake (SNOW), two names which investors have long been anticipating to see accelerating revenue growth due to generative AI but are still waiting.

Is PLTR Stock A Buy, Sell, or Hold?

There is no argument that the company is posting incredible financial numbers. My main concern is that of valuation. The stock trades just shy of 25x this year’s sales.

For reference, Salesforce (CRM) recently traded hands at 6x sales. Perhaps readers might contend that the growth profiles differ wildly. To that, my response would be that SentinelOne (S) trades at 9x sales in spite of posting a faster 30% top-line growth rate.

That’s what makes PLTR stock so interesting to me – this isn’t the same 2021 market in which tech stocks universally traded at bubbly valuations. PLTR is one of the few software names to still command a 2021-like premium multiple.

At 25x sales, the expectations are high. Consensus estimates call for around 18% to 20% revenue growth over the next 5 years, with the stock settling in at 9.5x, 2029e sales. Based on consensus estimates for 16% revenue growth in 2030, one could make a good argument that the stock is already more than fully valued for the next 5 years of growth. Specifically, I am saying that it is possible, if not likely, that PLTR trades at less than 10x sales in 2030, meaning that between now and then, investors might only receive the GAAP earnings yield (currently around 1%) as shareholder returns. Some investors might recognize this to be a potential case of “dead money.”

I note that the consensus estimates above already imply an acceleration to 29% revenue growth at some point. But perhaps one believes that revenue growth might accelerate to the 40% range for an additional one of those years. The company then might end up at around $8.5 billion in revenue in 2029. The stock would be trading at around 8x, 2029e sales. Assuming the stock trades at 10x sales by then, we are looking at around 4.5% annualized returns over the next 5 years, or maybe 5.5% to 6% inclusive of the earnings yield. That looks wildly insufficient for what should be regarded as an ultra-bull case.

I should address any doubts from readers who might be looking at Nvidia’s incredible acceleration to triple-digit-revenue growth and wondering why can’t PLTR do the same. The crucial difference between the two companies is the business model – software tends to offer more stable and recurring revenue streams, but on the other hand, it simply does not lend itself to huge surges in growth like that.

Moreover, if the main investment thesis for PLTR is for a continued acceleration in top-line growth as generative AI is further developed, then why not target stocks with a similar investment thesis but far lower valuations? Aforementioned names like MDB and SNOW are both growing at above-market rates and trade at less than half the valuation multiple.

PLTR Stock Conclusion

I am impressed by the continued strong fundamental results seen at PLTR, but the valuation is concerning to me. The stock trades at a 100% premium to even the highest valued names in my coverage universe, SNOW and MDB. There seems to be storm clouds hovering above the software sector, with many names seeing their stock prices plunge as they continue to cite macro pressures. I am now of the view that PLTR’s valuation has reached such lofty levels that it is worth moving from my prior neutral rating and downgrading the stock to a sell rating. I see great chances for poor returns relative to the broader market over the long term, and equally high chances for a sharp pullback on any earnings disappointment. I rate the stock a sell.