The Future of Defense Is Artificial Intelligence (AI). Here's Why Palantir Is My Top Choice.

It's been nearly impossible to avoid the term "artificial intelligence" over the last couple of years. Yet, despite the constant inundation of references to AI, I'd wager that most times you wind up hearing the same topics covered over and over.

For example, how many times have you heard about the impact AI will have on workplace productivity or how demand for graphics processing units (GPU) continues to soar?

While these are important applications for AI development, it's important for investors to seek out lesser-known opportunities as well. One area where AI is overlooked is the defense industry.

Here's how AI is playing an important role behind the scenes for defense contractors and why Palantir Technologies (NYSE: PLTR) is my top pick for this pocket of the AI arena.

One of AI's most overlooked opportunities

Over the last several years, corporate executives across all industry sectors have expressed the importance of investing in digital infrastructure in order to help their leaders make more informed and efficient decisions through the power of data.

Being able to look at key performance indicators and operating metrics in an easy-to-read format can help a business uncover important insights related to budgeting, supply chain and logistics, and many other use cases.

These same applications are pertinent to the defense sector. Branches of the military and government contractors also need to keep on top of finances, inventory levels, and logistical protocols.

While the public sector's needs may be more specialized compared to that of a private enterprise, the market opportunity at the intersection of AI and defense is quite large.

Mordor Intelligence estimates the global total addressable market for AI defense to be worth about $9 billion today, and it should grow to $16 billion by 2029. Moreover, Mordor cites the U.S. as the largest geographic market for AI defense. This is a good thing for Palantir, as the company's public sector business is focused on branches of the U.S. military and other Western agencies.

Image source: Getty Images.

How is Palantir winning the AI defense race?

About half of Palantir's entire revenue base comes from government contracts. Let's take a look at some notable deal flow the company has won in recent years.

Image source: Palantir.

A few years ago, the Department of Defense (DOD) tapped Alphabet to manage an initiative known as Project Maven. However, some of Alphabet's employees viewed the company's work with the U.S. military as controversial, ultimately leading to Alphabet leaving the project.

Palantir swiftly took advantage of this decision, and it has been managing the Maven contract ever since. After establishing this partnership, Palantir has won other notable deals with the DOD, including a five-year contract worth up to $480 million with the U.S. Digital and Artificial Intelligence Office, as well as a five-year deal worth up to $100 million with the Army Research Laboratory (ARL).

More recently, Palantir announced a strategic alliance with government contractor L3Harris Technologies. According to the press release announcing the deal, the partnership between Palantir and L3 Harris will focus on "a variety of ongoing initiatives, including collaboration on U.S. Army programs like TITAN and efforts aligned with the U.S. Army's Unified Network Strategy."

This is an important point to understand. Becoming more aligned with other contractors on existing contracts better positions the company for future renewals, thereby strengthening the company's recurring revenue base.

It's this dynamic that could lend credence to the idea that Palantir has yet to really begin scaling and is laying the necessary groundwork for larger opportunities down the road.

Is Palantir stock a buy right now?

Palantir stock has become increasingly expensive over the last few months. The AI narrative is undoubtedly fueling growth for the company across the top and bottom lines. While this is encouraging to see, shares of Palantir have soared to a point that's disconnected from the underlying fundamentals of the business.

As of this writing, Palantir boasts a market cap of $100 billion -- or roughly 43 times the company's trailing-12-month sales.

Data by YCharts.

As the chart above clearly illustrates, Palantir stock has experienced some outsized valuation expansion over the last few months. Although the company is well positioned in the AI landscape and should continue to emerge as a big-time winner, Palantir stock has gotten too pricey.

I don't think investors need to pour into the stock on the assumption that Palantir is some sort of hidden opportunity. The valuation trends above suggest otherwise. The long-term opportunity in the marriage of AI and the defense sector over the next several years is the more important idea.

Palantir reports third-quarter earnings on Nov. 4. I'm more inclined to wait and see what management has to say during the earnings call and what it could mean for the company's long-run prospects.

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Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. Adam Spatacco has positions in Alphabet and Palantir Technologies. The Motley Fool has positions in and recommends Alphabet and Palantir Technologies. The Motley Fool recommends L3Harris Technologies. The Motley Fool has a disclosure policy.