Why a P/E ratio of 424 doesn’t (necessarily) make Palantir shares overvalued

Stephen Wright turns to mountaineering and Warren Buffett to figure out how to value shares in an AI company that looks unstoppable right now.

| More on:

Image source: Getty Images

When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.

Read More

The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Investments in a currency other than sterling are exposed to currency exchange risk. Currency exchange rates are constantly changing, which may affect the value of the investment in sterling terms. You could lose money in sterling even if the stock price rises in the currency of origin. Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

Saying Palantir (NASDAQ:PLTR) shares are overvalued because the price-to-earnings (P/E) ratio is 424 is – I think – a mistake. It’s like saying someone can’t climb Everest because the mountain is big.

Someone’s ability to get to the top of Everest depends on their mountaineering skills. And the value of Palantir’s stock comes down to its future growth prospects – which I think are outstanding. 

Valuation

There’s more to valuation than P/E ratios. Don’t believe me? – here’s Warren Buffett in the Berkshire Hathaway Annual Shareholder Letter from 2000:

“Common yardsticks such as dividend yield, the ratio of price to earnings or to book value have nothing to do with valuation except to the extent they provide clues to the amount and timing of cash flows into and from the underlying business.”

This isn’t to say the P/E ratio is irrelevant (in the same way the height of Everest isn’t irrelevant to the question of whether or not someone can climb it). But it isn’t the only thing that matters. 

Ultimately, the value of a stock comes down to how much cash the company is going to make and when it’s going to make it. That’s as true of Palantir as it is of anything else.

The equation

Right now, Palantir has a market cap of around $190bn and a 10-year government bond comes with a yield of 4.5%. So to justify its current valuation, the business needs to make around $86bn by 2035.

That’s $8.6bn per year and the company managed just over $462m in 2024. That means there’s a lot of growing to be done, which could be inferred from the P/E ratio. 

To generate $86bn by 2035, Palantir is going to have to grow its earnings by over 50% per year. Again though, this only gives an idea of the scale of the challenge. 

It’s big, but it isn’t impossible. Just as an outstanding mountaineer can climb Everest, an exceptional business can achieve that growth – the question is whether or not Palantir is exceptional enough.

Palantir’s prospects

There’s a mountain to climb, but I find it hard to imagine a business with better prospects for doing it than Palantir. It provides real value to customers and a huge addressable market. 

During 2024, the company signed up companies from bottled water manufacturers to insurance brokers. And in the last three months alone, it brought on another 82 new customers.

As a result, US commercial revenues grew 64% in the fourth quarter of 2024. And there’s currently no visible competitor in sight, which is why CEO Alex Karp thinks there’s decades of growth ahead. 

That’s not to say there are no risks at all. The company acknowledges that the rise of artificial intelligence is likely to raise regulatory and legal challenges and investors can’t just ignore these.

Foolish takeaways

It’s not clear to me whether or not Palantir shares are good value right now and there are other opportunities where I think this is more obvious. So I’m focusing on other investments for my portfolio.

One thing I am clear on, though, is the idea that a high P/E multiple means the stock is overvalued is far too simplistic. With any shares, the question of value comes down to the underlying business.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Stephen Wright has positions in Berkshire Hathaway. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

More on Investing Articles

Investing Articles

How much does an investor need in a Stocks and Shares ISA to earn £1,000 a month in passive income?

A Stocks and Shares ISA's a valuable asset for investors. Not having to pay dividend tax can be a big…

Read more »

Investing Articles

9% dividend yield! Could buying this FTSE 250 stock earn me massive passive income?

Assura looks like an outstanding stock for dividend investors to consider. But is the 9% dividend yield the passive income…

Read more »

Man putting his card into an ATM machine while his son sits in a stroller beside him.
Investing Articles

Why I think this month could be critical for the Lloyds share price!

Our writer explains why he thinks the bank's 2024 results will have a significant impact on the short-term direction of…

Read more »

British Pennies on a Pound Note
Investing Articles

This former penny share has soared 168%. Is the best yet to come?

When Christopher Ruane saw a penny share as a potential bargain last year, he was spot on. So having not…

Read more »

Mature couple at the beach
Investing Articles

£20k in an ISA? Here’s how it could generate £1 of passive income every hour — forever

With a long-term approach, Christopher Ruane explains how an investor could aim to earn a pound per hour in passive…

Read more »

One English pound placed on a graph to represent an economic down turn
Investing Articles

FTSE shares: overpriced or still a bargain?

Christopher Ruane reckons a storming FTSE 100 performance of late doesn't tell us much about whether there are still possible…

Read more »

Blue NIO sports car in Oslo showroom
Investing Articles

Would an investor have made money investing £2k in NIO stock 5 years ago?

Our writer looks at how NIO stock has performed over recent years and weighs the bull and bear cases as…

Read more »

Young woman working at modern office. Technical price graph and indicator, red and green candlestick chart and stock trading computer screen background.
Investing Articles

5 steps to start buying shares with £5 a day

In a handful of steps, our writer explains how someone new to the stock market could start buying shares for…

Read more »