History says Palantir stock is overpriced. Is it time to sell?

Palantir (PLTR 1.00%) is a great example of a stock whose business is excellent, but whose stock may be too expensive to justify buying. After all, even the best companies bought at the wrong price can be a disastrous investment.

But what does history say about highfliers like Palantir?

Palantir’s AI product accelerated growth

Palantir’s product focus is on providing its customers with artificial intelligence (AI) powered software that helps in decision making. It was originally developed for government use, but Palantir eventually expanded into the commercial arena to capture a larger market opportunity.

Palantir has had AI software available for some time, but the release of its Artificial Intelligence Platform (AIP) product was a real game changer. AIP enables companies to integrate large language models (LLM) into their internal servers. This allows generative AI models to run on internal data, providing its users with the best information at all times. Because AIP provides customers with the tools to integrate AI into a business, it is key software that takes AI from a product that is used on the side to one that is fully integrated.

According to management, demand for AIP has been “unprecedented” and this growth is particularly evident in Palantir’s commercial segment in the US. In the second quarter, US commercial revenue grew 55% year-over-year, fueled by customer numbers that grew 83% year-over-year. While U.S. commercial revenue accounts for about a quarter of total revenue, the rest of Palantir’s business is also doing well. Overall, Palantir’s revenue rose 27% year-over-year to $678 million.

Management also expects the growth rate to continue to be strong. Third-quarter revenue is expected to reach $699 million, indicating revenue growth of 25 percent.

While these are solid results and guidance, is it enough to justify Palantir’s price?

Palantir stock outperformed its trading results

Palantir is profitable, but has not yet achieved an optimized profit margin, so I will use price-to-sales valuation to value the stock. At 35 times sales, Palantir stock is incredibly expensive.

PLTR PS report data by YCharts

The last time Palantir hit that level was in 2021, but that’s when its revenue grew about 40% year-over-year. Palantir’s growth rate is expected to moderate next quarter, and Wall Street analysts expect growth of just 21% next year. As a general rule, when a company’s price-to-sales (P/S) ratio exceeds its revenue growth rate, the stock is incredibly expensive and should probably be avoided.

Palantir is equal More more expensive than this rule of thumb, and history suggests that a correction may be imminent. This has been seen in other software stocks that were also excelling at some point. Zoom Video was booming with its video conferencing technology during the pandemic, but its valuation collapsed as demand was met.

ZM PS report data by YCharts

I don’t know if Palantir will be the next Zoom video, but one thing is for sure: Palantir stock is incredibly expensive. If you are on healthy earnings, it may be wise to cut some of that profit and leave it in cash or redistribute it to other opportunities available in the market.

The stock’s valuation far outstrips the actual business results, and I wouldn’t be surprised to see a selloff in the future.