This article first appeared on our US website.
Over the past three years, no innovation has captured the attention of Wall Street and ordinary investors as much as the evolution of artificial intelligence (AI). Providing software and systems with the tools to make split-second decisions without the need for human oversight is a game changer for most industries around the world, and a technological leap forward that could add $15.7 trillion to the global economy by 2030, PwC analysts said in Determine the price.
While Nvidia has been the clearest beneficiary of the AI revolution on a nominal dollar basis – its market value has increased by $4.2 trillion since the end of 2022 – the argument can be made that the AI data mining specialist Palantir Technologies (NASDAQ:PLTR) has knocked Nvidia off its pedestal.
Since the start of 2023, Palantir shares have risen approximately 2,780%, with the company adding more than $400 billion in market value. From the closing bell on October 24, it grew from a company of marginal importance in the technology sector to the twentieth largest listed company on the US stock exchanges.
With a move of this magnitude, you can bet that Wall Street and investors will be eagerly awaiting Palantir’s third-quarter operating results, which the company will release after the close of trading on Monday, November 3.
While Palantir has a habit of leapfrogging analysts’ consensus forecasts — in three of the past four quarters it has exceeded expectations by a double-digit percentage point — it seems much more likely that Palantir will disappoint Wall Street on November 3.
Palantir’s competitive advantage is on full display
But before investors can look to the future and make predictions, a foundation needs to be laid on how we got to a point where Palantir has become one of the most influential AI stocks in the world.
The key catalyst fueling Palantir’s outperformance is the company’s sustainable moat. Specifically, its two main operating segments lack large-scale competition, meaning Palantir doesn’t have to worry about the idea of other companies siphoning off its contracts or subscriber base.
The historic breadwinner for Palantir is its AI and machine learning-powered Gotham software-as-a-service (SaaS) platform. Gotham assists the U.S. government and its allies in collecting and analyzing data, as well as planning and monitoring military missions. This segment typically negotiates four- or five-year deals with federal governments that result in highly predictable operating cash flow and consistent double-digit revenue growth. Gotham is also the reason Palantir regularly became profitable, well above consensus expectations among Wall Street analysts.
The other core segment of SaaS is Foundry, which focuses on enterprises. This is a subscription-based service that helps enterprise customers understand their big data to improve supply chains and automate certain activities, to name just a small sample of the applications of this platform.
Palantir is one of Wall Street’s best examples of AI applications that transform and enhance the capabilities of cloud-based software. But even with an eye-popping growth forecast and a knack for beating analyst expectations on earnings per share, Palantir is likely heading uphill as it prepares to report third-quarter corporate results.
Wall Street’s AI darling has a near-impossible task to impress investors on November 3
Palantir’s biggest challenge comes down to one word: history.
History tells us that every breakthrough innovation and hyped technology that is more than thirty years old has fought its way through an eventual bubble in the early stages of its expansion. Without exception, investors have consistently overestimated the adoption rate and utility of next-big-thing trends, resulting in high expectations not being met. When the “next big thing” bubbles burst, the companies at the forefront of these trends often bore the brunt of the punishment.
The one thing Palantir has working in its favor is the relative predictability of its operating cash flow. Multi-year government contracts and a subscription-based platform with Foundry would likely protect the company from a revenue cliff in the event of an AI bubble. But this doesn’t mean Palantir stock is out of the woods.
Perhaps the bigger historical hurdle is Palantir’s stratospheric valuation.
Before the dot-com bubble burst, some of the most influential internet companies peaked with price-to-sales (P/S) ratios ranging from 30 to 40, with some wiggle room at the top end. Companies like it Cisco systems, AmazonAnd Microsoft were unable to maintain these high price-earnings ratios for a longer period of time.
PLTR PS Ratio data according to YCharts.
Taking into account that no mega-cap company has ever been able to maintain a price-to-earnings ratio above 30, Palantir Technologies closed on October 24 with a price-to-earnings ratio of almost 136! There’s no conceivable revenue or EPS guide that can calm the optimism to support a price-to-earnings ratio of 136. It would take several years of 40%-plus sustained sales growth to get Palantir’s stock back to the 30-to-40 price-to-earnings ratio range where previous bubbles peaked.
To complicate matters further, the federal government shutdown has lasted more than three weeks as of this writing. Palantir has traditionally relied on Gotham to do the heavy lifting and generate the lion’s share of its operating revenue. The shutdown blocks new deal opportunities in the short term.
When a stock is priced to perfection, Wall Street and investors will expect nothing less. The problem is that even the best companies stumble or slow down from time to time. Palantir’s astronomical valuation sets the stock up for disappointment on November 3.
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