Palantir Technologies Is a Stone's Throw From Making Dubious History -- and Decades of Precedent Tells Us What Happens Next

On Tuesday, Feb. 18, the benchmark S&P 500 rallied to yet another record-closing high. For more than two years, the bulls have had a tight grip on Wall Street's proverbial reins, with optimists being handsomely rewarded.

Catalysts have been abundant, with everything from excitement surrounding stock splits in influential businesses to Donald Trump's return to the White House fueling gains. But standing atop the pedestal of catalysts is the rise of artificial intelligence (AI).

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Empowering software and systems with the ability to reason, act, and evolve over time without the need for human intervention gives AI potential utility in almost every industry around the globe. According to the analysts at PwC in Sizing the Prize, this is a technology that can increase global gross domestic product by 26% ($15.7 trillion) come 2030.

Image source: Getty Images.

Although Nvidia's graphics processing units (GPUs) are what make the AI revolution tick, Nvidia has taken a back seat to the hype surrounding data-mining specialist Palantir Technologies (NASDAQ: PLTR), whose shares have more than quintupled over the trailing year. With a nearly $284 billion market cap, Palantir has emerged from relative obscurity to become the 32nd-largest publicly traded company and 10th-biggest tech stock traded on U.S. exchanges.

But as the old saying goes, "when things seem too good to be true, they usually are."

A well-defined moat and ideal positioning have fueled Palantir's parabolic ascent

Before digging into Palantir's dance with dubious history, let's dig into how we got to this point where it's suddenly one of the most-influential tech stocks (if not businesses) on the planet.

It all begins with the company's AI-driven Gotham platform. This software-as-a-service (SaaS) solution is geared at helping federal governments collect and sort copious amount of data, as well as plan and execute military missions. The contracts Palantir negotiates for Gotham tend to be four or five years in length, which results in relatively steady operating cash flow.

It should also be noted that Gotham almost single-handedly lifted Palantir to a generally accepted accounting principles (GAAP) profit well ahead of Wall Street's consensus forecast. A recurring GAAP profit demonstrates that Palantir's operating model is sustainable.

Palantir's other core operating segment is Foundry, which is a machine learning-powered platform that helps businesses make sense of their data. It can be used to build web applications, improve supply chains, and integrate data across multiple platforms. Since this segment is still relatively new, it should have no trouble sustaining a double-digit growth rate for years to come.

Collectively, other businesses may offer bits and pieces of what Gotham and Foundry bring to the table. But on a large-scale basis, there isn't a one-for-one replacement for Palantir's SaaS solutions. Having an irreplaceable product or service is an easy way to garner a hearty valuation premium on Wall Street.

The other factor that's playing a key role in Palantir's parabolic ascent is its ideal positioning under the Trump administration. President Trump has the ability to reshape AI policy over the next four years, and he's, thus far, signaled support for an America-first approach that encourages domestic AI innovation. In other words, it perfectly sets up Palantir to win government contracts.

Although Palantir has made mincemeat out of skeptics to this point in its existence, history tells a different tale of what's to come for Wall Street's hottest AI stock.

Image source: Getty Images.

Palantir is on the verge of making dubious history

If not for Nvidia's epic climb that saw the AI-GPU giant gain $3 trillion in market cap in less than two years, Palantir's more than $260 billion in added market cap over the last two years would be the talk of Wall Street. Unfortunately, valuation could be precisely what sends Palantir stock over the proverbial cliff.

To clear the air, "value" is a subjective term. What one investor believes is pricey might be viewed as a bargain by another. Every investor has their own unique goals and risk tolerance levels, which makes "value" something of a fungible term.

Nevertheless, investors commonly rely on the price-to-earnings (P/E) ratio as a quick way to determine if a stock (or a broad-market index) is relatively cheap or pricey. This P/E ratio is arrived at by dividing a company's share price by its trailing-12-month (TTM) earnings per share. While this method works great for mature businesses, the P/E ratio can get easily tripped up by high-growth stocks.

One of a small handful of valuation tools that can be of help when evaluating high-growth stocks like Palantir is the price-to-sales (P/S) ratio, which is determined by dividing a company's market cap by its TTM revenue.

Palantir's P/S ratio is astronomically high. As of the closing bell on Feb. 18, Palantir's P/S ratio tipped the scales at 99.05! It's a stone's throw away from making dubious history and trading for a triple-digit P/S ratio.

PLTR PS Ratio data by YCharts. Note: Palantir's P/S ratio is based on TTM sales through Sept. 30, 2024, in the above chart.

To put into context just how far out of historic norms this is, let's take a brief look at the peak P/S ratios of other market-leading businesses for next-big-thing technologies/innovations over the last three decades.

• Amazon, which is viewed as a leader of the dot-com era, peaked at a P/S ratio of 43.29 on Jan. 11, 1999.
• Cisco Systems, a leading provider of networking solutions during the dot-com boom, topped out at a P/S ratio of 38.92 on March 27, 2000.
• AI colossus Nvidia peaked at a P/S ratio of 42.39 on June 18, 2024.

These are three market leaders that all peaked at similar nosebleed P/S ratios. Palantir's P/S ratio of 99.05 blows them all out of the water.

More importantly, Amazon and Cisco Systems both lost in the neighborhood of 90% of their respective value after their P/S ratios peaked. Their downfall serves as a reminder that every next-big-thing innovation/technology over the last 30 years has endured a bubble-bursting event. Even though Palantir's contract-based revenue should keep its operating cash flow from falling off a cliff, it wouldn't be immune to a bursting of the AI bubble.

Decades of precedent paints a clear picture that Palantir's parabolic ascent is, eventually, going to reverse course.

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John Mackey, former CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Sean Williams has positions in Amazon. The Motley Fool has positions in and recommends Amazon, Cisco Systems, Nvidia, and Palantir Technologies. The Motley Fool has a disclosure policy.