When the book closed on 2024, Wall Street had plenty of reason to cheer. The Dow Jones Industrial Average, S&P 500, and Nasdaq Composite respectively increased in value by 13%, 23%, and 29%, with all three indexes achieving numerous record-closing highs.
Investors didn’t have to dig deep to find catalysts, which include everything from Donald Trump’s Election Day victory — Trump oversaw gains of 57%, 70%, and 142%, respectively, in the Dow, S&P 500, and Nasdaq Composite during his first term — to stock-split euphoria. But topping the list is, unquestionably, the rise of artificial intelligence (AI).
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With AI, software and systems are given the ability to become more effective at their assigned tasks, and can, over time, learn to do new tasks without the aid of human intervention. This capacity to learn, reason, act, and evolve gives this technology seemingly limitless long-term potential.
Although graphics processing unit (GPU) goliath Nvidia is the company that’s served as the face of the AI revolution, it actually took a back seat in 2024 to data-mining specialist Palantir Technologies (NASDAQ: PLTR), which was the top-performing member of the S&P 500 with a return of 341%!
The question that needs to be asked is this: Is Palantir’s parabolic climb, which 10X’d its market cap over the trailing-two-year period, too good to be true? History can be a guide to help determine whether or not Palantir stock can decline below $40 per share in the new year.
Before diving into the nuts-and-bolts of whether or not Palantir’s vertical ascent can stand the test of time, it’s important to know how we got to the point.
Arguably the easiest way to earn a premium valuation on Wall Street is to be irreplaceable. Palantir’s AI-driven Gotham platform and machine learning-inspired Foundry service simply can’t be replicated at scale.
Gotham is the service Palantir offers to federal governments to help with data collection, as well as various aspects of mission planning, procedures, and execution. This is a segment that typically locks in contracts from the U.S. government and its closest allies that span four or five years. Multiyear contracts tend to produce highly predictable cash flow, and there’s little concern about payment since federal governments are the client. Gotham is primarily responsible for Palantir shifting into the recurring profit column well ahead of Wall Street analyst’s expectations.
Meanwhile, Foundry is the company’s enterprise-facing AI offering that helps businesses make sense of their data. In addition to analyzing copious amount of data, it can help automate the decision-making process, thereby boosting the bottom line of the businesses using this service.
Palantir stock really took off following President Trump’s victory in November. Trump’s approach to regulating AI will be to foster domestic innovation, as well as protect America’s interests and information. As one of the key AI service providers to the U.S. government, Palantir is perfectly positioned to take advantage of the Trump administration’s focus on national security.
Lastly, Palantir’s balance sheet has made it a bit more palatable for investors to pay a premium for the stock. It closed out the September quarter with $4.6 billion in cash, cash equivalents, and short-term investments, which provides plenty of capital for ongoing innovation, as well as share buybacks.
Image source: Getty Images.
With a better understanding of how Palantir’s market cap soared to $166 billion, as of the closing bell on Jan. 21, let’s allow history to be our guide and determine whether or not Palantir is likely to retrace from $73 per share to $40 (or below) in 2025.
One of the biggest headwinds Palantir is set to contend with in the new year is historic precedent. For roughly three decades, every game-changing innovation that investors were hyped about navigated its way through an early stage bubble-bursting event.
For instance, anything related to the internet soared during the mid-1990s as this new technology went mainstream. However, the dot-com bubble wiped out nearly half of the S&P 500s value on a peak-to-trough basis in the early 2000s, with the tech-heavy Nasdaq Composite losing 78%. Even though the internet was transformative for businesses, it took years before they figured out how to maximize its potential.
Every next-big-thing trend needs time to mature, and there’s no evidence that artificial intelligence is going to be the exception to the rule. If an AI bubble were to form and eventually burst, AI companies with premium valuations, such as Palantir, would likely be hit the hardest.
Another possible issue for Palantir is the natural ceiling built into its (currently) most-profitable operating segment. While new contracts for Gotham have helped sustain annual sales growth of around 25%, Gotham’s reach is limited. This is to say that most countries wouldn’t be allowed access to its AI-driven platform. With a reasonably limited customer base, this puts a long-term ceiling on what can be expected from this operating segment.
But the biggest historic concern may very well be Palantir’s valuation.
PLTR PS Ratio data by YCharts. PS = price-to-sales.
Admittedly, value is in the eye of the beholder. Investors have different goals and levels of risk tolerance. But as of Jan. 21, Palantir stock was valued at an estimated 152 times forward-year earnings and 66 times trailing-12-month (TTM) sales.
To put this into perspective, Cisco Systems and Amazon were two of the biggest “faces” of the dot-com era. When they respectively peaked before the dot-com bubble burst, they traded in the neighborhood of 40 times TTM sales. For top businesses on the leading edge of a next-big-thing innovation, 30 to 40 times TTM sales has been a common peak and sign of a bubble. Palantir’s TTM price-to-sales ratio is nearly double this range.
A final note: 36% of Palantir’s roughly $391 million in net income through the first nine months of 2024 can be traced to interest income generated on its cash. Though there’s nothing wrong with generating interest income on cash, it’s concerning that a stock boasting nosebleed valuation premiums is getting over a third of its net income from an unsustainable/noninnovative source like interest income.
Palantir’s moat and its long-term government contracts should provide some downside support for the company’s stock. However, the parabolic move higher it’s enjoyed doesn’t appear sustainable. Based on what history tells us, a move down to $40 per share at some point in 2025 wouldn’t be a surprise.
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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.
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