Palantir Technologies Inc. (PLTR, Financial) is one of the most innovative companies on the market right now as its artificial intelligence and data services products are transforming not only commercial sector operations, but also government and intelligence operations for Western allies, including the U.S. However, the market already fully appreciates the value in the stock and, in my opinion, its valuation multiples are too high despite the strength indicated in second-quarter results. Wall Street also holds the consensus the stock will contract in price over the next 12 months, and I think this is likely.

Despite this outlook based on valuation risk, Palantir is one of the most exciting AI stocks, and its recent partnership with Microsoft (MSFT, Financial) and strong growth potential in its commercial division, aided by a clever Bootcamp sales model, bodes extremely well for the long-term future of the company. I am long-term bullish on the stock, but I am waiting for a better valuation.

Artificial intelligence platform, government relationships and commercial presence

Palantir benefits from exceptional proprietary technology, particularly with its Artificial Intelligence Platform, which is a significant driver of its growth. Further, the company has a range of proprietary software platforms, including Gotham, Foundry, Apollo and AIP, to provide state-of-the-art data integration and analysis capabilities.

The AIP is particularly noteworthy as it leverages large language models, connecting to enterprise data, logic and systems of action. It also allows for the deployment of LLMs and AI tech across private networks, enhancing security and compliance in sensitive industries like defense. So far, AIP has been a big revenue driver in Palantir's commercial sector performance. This has been demonstrated in its strong U.S. commercial revenue growth of 55% for the second quarter.

Palantir also has strong relationships with government agencies, positioning itself with a niche and with a reputation and level of trust that is hard to develop. Its relationships include the U.S. Department of Defense and the CIA, providing a stable and substantial revenue stream. This high barrier to entry use case for AI is what makes me most bullish about Palantir. In addition, it makes the company an integral part of future international relations and strengthens the West with AI-backed security mechanisms.

Quarterly results, valuation analysis and one-year price target

In the second quarter, Palantir's number of U.S. commercial customers increased from 161 a year ago to 295. It signed 27 deals worth $10 million or more, nearing $1 billion in total contract value, and its U.S. commercial annual contract value was up 44% year over year and 19% sequentially. The company has also launched Warp Speed, which aims to revolutionize American manufacturing and aligns with national defense and reindustrialization efforts. Further, Palantir's net retention rate has been improving and reached 114% in the second quarter, providing evidence of successful upselling and expansion within existing customer accounts.

Despite these strong results and the indication of strong long-term growth on the horizon, I believe the stock is overvalued. This is made evident by the price-earnings ratio of over 180, which, without non-recurring items, comes down to a still very high 97. Its price-sales ratio is also nearing 30. There are very few companies in technology trading at such high valuations, and even Tesla (TSLA, Financial), which is notorious for its high valuations, trades at a cheaper earnings multiple of around 59 currently.

There is clearly a lot of reason to be bullish about Palantir, but I am not sure this high valuation is justified. My overvaluation thesis is further supported by the GF Value Line, which indicates the stock is significantly overvalued.

Further, on a price-sales ratio basis, Palantir is only less richly valued than Nvidia (NVDA, Financial), but more richly valued than Amazon (AMZN, Financial), C3.ai (AI, Financial) and Tesla. This outlines the premium investors are paying, which is concerning to me when we compare the revenue growth rates of Nvidia and Palantir, making me wonder whether the stock deserves such a high valuation.

In my opinion, a fairer price-sales ratio for Palantir would be lower than 20. The issue with the ratio nearing 30 and other valuation multiples being very high is that one operational failure, like what happened recently with CrowdStrike (CRWD, Financial), which is also very highly valued, can cause a massive setback in price. This is why I think Palantir is too high risk for a large weight in portfolios, and I currently do not own the stock primarily based on overvaluation concerns.

The average Wall Street price target for Palantir indicates a potential 19% downside for the stock. The GuruFocus price target is an even lower $20.80. Therefore, I consider Palantir a hold based on this consensus, even though the future three-year earnings per share without non-recurring items growth is estimated to be 23.70% and revenue 20.40%.

Customer growth, sector exposure management and competitive risks

Despite having a strong product and service set, the company has struggled with customer retention and acquisition. This is demonstrated by inconsistency thus far in perfomance in fundamental growth, although this is now hopefully being amended through its module-based sales model moving forward, which should provide more growth stability as it allows users to enter the platform gradually rather than invest in the full platform offered by Palantir at the start.

Furthermore, Palantir's dependence on government contracts makes it vulnerable to changes in the federal budget, as well as opens it up to high levels of responsibility during times of war, like in Ukraine and the Middle East. While this can be revenue-generating, in worst-case scenarios, it can strain its commercial revenue and place the company in positions where it needs to put geopolitical outcomes above pure profit and revenue generation. The company's original clients were federal agencies of the U.S. intelligence community—however, it is now expanding to serve both international and local governments; this could create conflicts of interest, and its exponential growth potential is limited as a result of this.

The data analytics and AI sectors are also heavily competitive. Robust competition from commercial-sector data services companies like Databricks, Alteryx (AYX, Financial) and Tableau could threaten Palantir's market share, especially if it begins to focus on its government contracts as a result of heightened geopolitical risk during this time of growing multipolarity. To mitigate this, Palantir has to ensure it balances its focus between its two core segments, commercial and government, carefully. A failure to do so could mean the company loses a lot of future revenue potential due to competitive threats eating away at market share in one or both of its markets.

Future growth drivers that could support sentiment

Despite being extremely richly valued, Palantir could sustain a high valuation if it continues to grow its capabilities in AI in sensitive and high-profile use cases. I believe the recent partnership with Microsoft, which will enhance its analytics and AI services for classified networks within the U.S. defense and intelligence community, integrating OpenAI service with Palantir's AI Platforms, bodes extremely well for the long-term growth and sustenance of the company. Foundry, Gotham and AIP will be deployed on Microsoft's Azure government and classified clouds, which should increase the adoption of Palantir's AI solutions within the federal sector.

In my opinion, this is just the beginning of Palantir's potentially broad big tech integration, bolstering its ability to build defense and enterprise use cases for AGI and establishing a moat for itself, which will be almost entirely unique and incredibly valuable for Western defense and international commercial leadership.

Palantir has also set up AIP Bootcamps, which is a strategic initiative to boost sales, especially with commercial clients. These are intensive workshops designed to outline how organizations can integrate AI into their operations. The company has conducted over 915 bootcamps since mid-2023, and this has significantly contributed to its 40% year-over-year expansion in the U.S. commercial business. This is also highly efficient for the company in both sales and marketing spend, and should improve margins as well as boost top-line growth.

These are two fundamental reasons why I believe Palantir could continue to sustain its high valuation moving forward. If the company comes up with more strategic partnerships and growth strategies like these, I believe the bullish sentiment could expand further. Palantir could still be considered a young company despite a high market cap of $68 billion. It is conceivable that it will become one of the larger tech companies as its capabilities in AI defense and high-profile, sensitive commercial applications scale. As a result, despite short-term volatility that could occur related to the valuation, I still think Palantir could be rationally bought at this time to hold for 10-plus years and potentially make substantial alpha.

Conclusion

Palantir is currently overvalued in the short term despite being an excellent company with strong fundamental growth likely over the long term if it can carefully manage its contracts and time between commercial and government clients strategically. I believe that due to the valuation, it is likely the stock will contract in price over the next 12 months.

As a result of my valuation analysis, I consider Palantir a hold and I am not buying it at this time, but I will potentially in the future if its price-sales and price-earnings ratios become more reasonable. Despite this outlook, the company's Microsoft partnership and Bootcamp growth strategy bodes well for the long term. If the company can engage in more moat building similar to this over the next five to 10 years, I think the company could generate alpha if bought at this time and held for a decade or more.