Contrarian Opinion: President Trump's Pentagon Budget Reductions Will Benefit Palantir. Here's Why.

For much of the last year, any time investors got news related to Palantir Technologies (NASDAQ: PLTR), that news was overwhelmingly positive. In 2024, the data analytics specialist's stock was the top performer in the S&P 500 (SNPINDEX: ^GSPC). It was also added to the Nasdaq-100 index, and institutional investors finally warmed up to a business they had previously viewed as too heavily reliant on U.S. government contracts.

However, as smart investors know, no stock can go up in a straight line forever. And Palantir just hit its first major snag in quite some time.

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Over the last 10 days or so, shares of Palantir have cratered by 24%. The sell-off was linked to a series of orders out of the White House that spooked investors.

Let's explore the specifics surrounding Palantir stock right now, and I'll explain my contrarian view that the current sell-off is overblown.

Breaking down the details around the Pentagon budget

In mid-February, President Trump expressed an interest in making some major changes to the nation's defense budget. On the surface, it appears that he is looking to identify cost reductions across the military and related defense agencies.

However, the details are still being refined.

Shortly after President Trump's suggestion, Secretary of Defense Pete Hegseth announced that the Pentagon would be looking to modify its budget by 8% annually over the next five years.

I want to emphasize my use of the word "modify." While some pundits perceive the President's orders as demanding budget cuts, Secretary Hegseth has suggested that the Pentagon is working to identify programs that the administration deems non-pertinent to the military's core mission (national security) and then, per a Defense Department press release, redirect those funds to be "spent on programs aligned with President Trump's priorities."

Image source: Getty Images.

I'm not surprised by these orders

Back in November, the Department of Defense completed its seventh annual audit in a row that resulted in a "disclaimer of opinion." That's basically a formal way for auditors to say they cannot confirm the total accuracy of financial statements. Given that the Pentagon's budget is around $850 billion, it's a bit disconcerting to learn that internal auditors have failed to fully account for the flow of funds for seven consecutive years.

In my mind, this dynamic was one of Trump's inspirations in his creation of the "Department of Government Efficiency" (DOGE), which he tapped Elon Musk to lead. And considering that DOGE is taking a magnifying glass to programs across the government, why wouldn't the Pentagon receive some increased scrutiny, particularly given its history of failing audits?

To me, it was obvious to expect that the President would task Secretary Hegseth with finding ways to trim and reallocate some of the Pentagon's budget.

Palantir could benefit from these budget cuts

The chart below illustrates the magnitude of Palantir's sell-off following news that the Pentagon had been ordered to find places to cut its budget. The main reason the shares took such a nosedive is that Palantir works closely with the U.S. government -- and, in particular, with military and intelligence agencies. In fact, more than half of Palantir's revenue comes from government contracts.

PLTR data by YCharts.

While no details are available yet, my suspicion is that the proposed 8% change to the Pentagon's budget will come through a combination of cost reductions and reallocations from non-core programs into more directly defense-centric initiatives.

On top of that, I tend to think most of the cost savings from these changes will come through reductions in employee headcount. It's not uncommon for workforces at large corporations to become bloated. For this reason, when companies decide to make major spending cuts, they almost always begin with layoffs, then follow up by identifying non-core vendor spending to reduce.

While the Pentagon may indeed begin slashing spending and renegotiating contracts with certain vendors, I expect Palantir will end up a major beneficiary of this cost-cutting plan. Its software programs have several artificial intelligence (AI) features integrated into them. Specifically, its AI platforms can help large enterprises model dynamic scenarios that account for changes in logistics, vendor procurement processes, headcount, inventory, and many other variables. As such, I think that rather than reducing the amount it spends with the company, the Pentagon will rely more heavily on Palantir to help it streamline its budget.

Lastly, Palantir tends to work with the Defense Department in highly classified environments. While the exact use cases for its tech are generally kept secret, I'm inclined to think the Pentagon will not cut spending on contracts with companies like Palantir that assist it in mission-critical operations.

For these reasons, I think Palantir's relationship with the government could become even closer as Washington adjusts the Pentagon's budget.

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Adam Spatacco has positions in Palantir Technologies. The Motley Fool has positions in and recommends Palantir Technologies. The Motley Fool has a disclosure policy.