The stock price of data analytics company Palantir Technologies (PLTR 0.51%) has been on a tear since it reported its first-quarter 2023 earnings on May 8. Investors became bullish after the company beat analysts' revenue and earnings estimates and forecast profitability for the rest of 2023.
Following the earnings release, Ark Invest CEO Cathie Wood, a particularly vocal supporter of Palantir, bought millions of shares of the company through her Ark Innovation ETF and Ark Next Generation Internet investment funds. Her acquisition of the stock apparently boosted market sentiment toward Palantir and helped increase demand for its shares. Wood and her investment firm have had some success in the past at selecting technology sector winners.
The stock price rose 132% between the Q1 report's release day and the day it released its second-quarter results on Aug. 7. The stock's price-to-sales (P/S) ratio of 6.9 at the beginning of 2023 rose to a P/S above 21 as of Aug. 1.
Given all this valuation appreciation over such a short time, is Palantir stock now way overvalued? Let's see if we can answer that question.
Palantir created some of its own headwinds
Palantir's second-quarter earnings last week failed to wow investors. One worry is that the company's P/S on the day it released earnings was 19, but Palantir reported Q2 revenue only rose 13% year over year. When a P/S ratio exceeds a company's growth rate, investors are paying a premium for the business's growth potential. A P/S that high also suggests investors expect Palantir to grow faster than it has in the past. The positive hype for the company did not help it achieve the growth the market has priced into the stock.
Palantir's unique sales model may be at fault here. It allows customers to test the platform for a trial period at no cost. This sales approach is meant to demonstrate the value of its products, with the hope that customers will make an initial purchase and increase their use over time. It requires significant investments of time and resources to acquire and maintain customers. And expanding this sales model to a global scale might face difficulties and has potential execution risks.
Then there is CEO Alex Karp's philosophy around the need for a sales team (or, more correctly, the thought that a sales team wasn't needed). He said he believed the software was so good that it could sell itself. That strategy might have worked in its U.S. government business. However, it was a terrible strategy for gaining customers in the commercial sector.
For instance, Palantir established its first commercial product, Foundry, in 2016. After building up a sales team from scratch in 2019, it managed to eke out only 34 customers by the second quarter of 2021. Although the company has significantly accelerated its U.S. commercial customers to 161 as of the second quarter of 2023, its unconventional sales practices make some investors wary of buying the stock.
Another headwind is Palantir's acquisition strategy. In an ill-conceived, desperate, and perilous move to boost growth, it invested in about two dozen early-stage companies in 2021, primarily former special purpose acquisition companies (SPACs). Palantir ostensibly made this move in exchange for the start-ups agreeing to become Palantir clients in the future. But many of these companies eventually faced cash flow problems, regulatory scrutiny, and lawsuits, hurting their performance. It ended up being a money-losing disaster.
Palantir announced the winding down of its SPAC investment program in 2022 and said it would focus on its core business of data analytics and software solutions. According to one analysis, Palantir lost more than $300 million on those investments.
Combined, these issues have caused some to no longer trust this management team.
Palantir investors have reasons for being bullish
There are still reasons to like this company. Palantir is still seen as a game changer in the data analytics and software industry. Its unique technology cannot be easily duplicated or substituted by other data analytics and software tools.
The company's most significant advantage is that it can deploy its software faster, cheaper, and more efficiently than other data analytics and software tools. Plus, its software is renowned for its ability to securely handle even the most sensitive data, providing organizations with peace of mind that their data is secure. It's no wonder that top U.S. intelligence agencies and the U.S. Special Operations Command all trust Palantir to safeguard valuable data.
The company is also getting a lot of buzz lately about its new Artificial Intelligence Platform (AIP). Investors are excited about its potential. It designed AIP to assist military and business customers with integrating, deploying, and managing artificial intelligence (AI) solutions.
With the rise of AI tools including ChatGPT from OpenAI, many anticipate that AIP will be a significant revenue driver for Palantir. Management has already reported seeing an overwhelming interest in its AI technology from customers and expects demand for its services to multiply.
Palantir investors should be cautious
A good company with excellent technology may not be a good stock if its price is too high relative to growth prospects, or if it faces significant risks. Despite Palantir's second-quarter 2023 post-earnings sell-off, the stock is still quite expensive, considering the growth it has shown so far and considerable investment risks.
While Palantir stock is up 143% so far in 2023, it's still down 60% from highs set in early 2021. That suggests volatility is still the name of the game here. It takes a brave investor to hold on to shares of this company, and those who own them might want to consider selling as bad management decisions seem to be sidetracking this company's potential.
