With a 2500% increase and a price-to-earnings ratio far exceeding NVIDIA, will Palantir be another valuation trap?

The surge in Palantir Technologies (PLTR.US) has further pushed its market value to a historic high, forcing bullish investors to pin their hopes on the company's future stronger growth to support its current valuation levels. The stock of this defense manufacturer hit another all-time high at the close last Friday, with an increase of nearly 2500% since its listing in 2021. The stock has risen nearly 150% so far this year, driven by the company's ongoing applications of artificial intelligence, its business ties with the U.S. government, and the recent release of excellent financial results.

According to the Zhitong Finance APP, this growth has made Palantir's stock price extremely expensive, especially compared to other peers: its price-to-earnings ratio is as high as 245 times, making it the most highly valued company in the S&P 500 index. In contrast, another chip manufacturer that has seen significant gains, NVIDIA (NVDA.US), has a price-to-earnings ratio of only 35 times.

Morningstar analyst Mark Giarelli stated, "Palantir's valuation situation is becoming somewhat tricky, but the company itself is excellent." He rated the stock as "sell," noting that the valuation issue "is uncomfortable, but that's the situation right now."

Many Wall Street professionals and ordinary investors are currently choosing to continue holding the stock, fearing they might miss out on greater future upside. However, they are also finding it increasingly difficult to ignore the fact that Palantir must meet higher standards to maintain its current performance in the long term. Bloomberg analyst Damian Reimertz estimates that the company needs to achieve $60 billion in revenue over the next 12 months to attain a valuation level comparable to its peers.

This calculation is based on a comparison of the enterprise value-to-sales ratio of software companies, which is significantly higher than Wall Street's expectation that Palantir will achieve $4 billion in revenue in fiscal year 2025, and also higher than analysts' forecast of $5.7 billion in revenue for next year.

For Gil Luria, Managing Director and Head of Technology Research at DA Davidson & Co., the valuation issue is also a tricky one. Luria praised Palantir's quarterly performance in a recent report, calling it "the most outstanding story among all software products." However, he estimates that the company must maintain a growth rate of 50% annually over the next five years and sustain a profit margin of 50% to bring its future price-to-earnings ratio down to 30, aligning it with companies like Microsoft (MSFT.US) and AMD (AMD.US). Palantir's adjusted earnings per share are expected to grow by 56% this year, followed by declines to 31% and 33% in the next two years From a broader perspective, the unease on Wall Street is becoming increasingly evident: data shows that the number of analysts rating the stock as "sell" or "hold" is more than double those rating it as "buy." However, Aptus Capital Advisors analyst David Wagner stated that for fund managers striving to outperform benchmarks, Palantir's stock has become a must-hold choice. The firm holds shares of Palantir.

Wagner pointed out, "Many investors cannot ignore this. They are not optimistic about the stock, but they are truly weary of the negative impact it has on their relative performance."

Discussion on Extremely High Valuation Precedents

Bullish investors in Palantir firmly believe that the company's business performance will support its stock price in the long term, a strategy adopted by many large tech giants today. For example, the online streaming company Netflix (NFLX.US) had a peak price-to-earnings ratio of over 280 times in 2015, while its current P/E ratio has dropped to 40 times.

Que Nguyen, Chief Investment Officer of the equity strategy department at Research Affiliates, stated, "There is no doubt that Palantir is part of that AI boom, but not all companies with valuations reaching $200 are part of a bubble." He was referring to Netflix.

Piper Sandler analyst Brent Bracelin raised the stock's target price from $170 to $182 after Palantir announced its earnings report, maintaining an "overweight" rating. He expects the company to continue its strong growth trajectory and maintain a high free cash flow ratio before 2030, thanks to the anticipated $1 trillion in U.S. defense spending.

He said, "You have to squint to see it. You have to try to believe that these ambitious growth targets are achievable."

Of course, there are many instances where stock prices rise due to companies failing to meet Wall Street's overly high expectations and gradually cooling off. For example, Tesla's (TSLA.US) stock price has fallen nearly 20% this year, partly because the company's performance has not matched its expected P/E ratio of about 148 times.

Giarelli from Morningstar stated that although Palantir's recent earnings report was excellent, its high valuation could trigger a sell-off if the company experiences a downturn in the future. He said, "Palantir's stock price has an excessively high P/E ratio compared to other companies. There is immense pressure behind its stock price chart. Given the rapid rise in the company's stock price, it is highly likely to adjust downward." For Chief Investment Officer Mark Malek, valuation remains a concerning aspect. However, Palantir's growth potential keeps him holding onto the stock. He stated, "It's certainly not comfortable to buy it at this price, but we won't shy away from buying when the stock is overvalued. Besides, where else can you find a 30% growth rate?"