Is This New S&P 500 Stock a Sell After Soaring 161%?

It’s been a year to remember for shareholders of the data analytics and artificial intelligence (AI) software company. Palantir Technologies (PLTR -0.70%). Shares are up more than 160% in the past year, and the committee that chooses the companies that deserve to join the S&P 500 added to the large-cap benchmark this month. Index inclusion is a badge of honor that recognizes a company’s strong performance and raises its awareness among investors.

Palantir’s products, particularly its AIP platform, are driving accelerated revenue growth and strong profitability. However, the share price rose faster than the underlying business. Should shareholders consider selling while they’re ahead, or does Palantir have more room to run?

The stock outperformed the business

I’m not here to handle Palantir’s business. There’s a lot to be excited about.

The company has become arguably the leading AI software play on Wall Street. It debuted the AIP platform last year as a tool for companies to develop and deploy custom AI applications, and its revenue growth has steadily accelerated since then. Technological consulting firm Forrester Research recently recognized AIP as the best AI and machine learning platform on the market.

And yes, its inclusion in the S&P 500 likely generated some buying momentum for the stock. Funds that track the S&P 500 must add Palantir shares to reflect the index, and many investors gravitate toward S&P 500 companies because they must meet strict standards to enter the index.

The problem is that stock price gains have dramatically outpaced business growth. Palantir’s trailing 12-month revenue rose a total of about 16%. Stock appreciation has outpaced it by a factor of nearly 10.

PLTR Revenue (TTM) data by YCharts.

How expensive is Palantir?

In reality, stock prices at any given time largely reflect the level of market enthusiasm for that stock. Part of investing is recognizing when the market is too excited or pessimistic.

Right now, market sentiment towards Palanir is borderline frenetic.

Remember the “everything bubble” of 2020-2021, when zero percent interest rates and soft-money fiscal policies put in place to keep the economy stable during the pandemic crisis fueled a speculative bubble between growth stocks, cryptocurrencies and other assets? Although broad market indices are once again setting new all-time highs, many growth stocks are still trading at fractions of the valuations they achieved at the peak of that bubble.

However, on a price-to-sales (P/S) basis, Palantir is nearing the highest valuations it had during the bubble.

PLTR PS report data by YCharts.

Analysts expect the company to generate revenue of $2.76 billion in 2024 and $3.32 billion in 2025. The stock is trading at a forward P/S of 25, based on next year’s revenue estimates. If the stock eventually settles at a long-term P/S ratio somewhere in the middle of that wide range — say, 15 times earnings — its chart could go bumpy or fall for years, while the business grows enough to catch up. share price.

Should Investors Sell Palantir?

Palantir’s valuation has likely entered bubble territory, and a number of factors could cause that bubble to burst. There is political uncertainty as the US election approaches. Geopolitical tensions flare in Europe and the Middle East. Now that US inflation is largely under control, the Federal Reserve has started to cut interest rates, which should boost the economy. But when such a stimulus is needed, it’s sometimes because the country is headed for a recession.

Stock bubbles can also appear on their own. Remember, high ratings create high expectations. Palantir stock could continue to rise until the company inevitably hits the incredibly high standards the market has priced into the stock. Once that happens, the resulting correction could be sharp.

In other words, stock bubbles are like a game of musical chairs. It always ends eventually.

For investors, selling winners while they’re still winning is difficult, and anyone who bought Palantir as recently as the past few months is likely to have fantastic gains and feel good about it. But selling some shares to lock in your gains might be wise. Otherwise, you might regret it when the music stops.