Palantir ( PLTR -5.81% ) is one of the top AI companies in the market. Its stock price has risen dramatically over the past few years, and its business growth is to credit for that.
But where will Palantir be in three years? My answer may come as a shock to some.
Palantir's AI tools are incredibly popular
Palantir has been in the AI game longer than most. It started as a company that made AI-powered data analytics software for U.S. government agencies, but then broadened its horizons to cater to the needs of commercial clients. This approach has paid off for Palantir, and both parts of its business are delivering huge growth thanks to its Artificial Intelligence Platform (AIP), which helps businesses integrate generative AI tools into their existing systems.
In the second quarter, Palantir delivered incredible growth, with revenue rising 93% year over year to nearly $2 billion. What separates it from some of its peers is that its growth isn't just on the top line, but also on the bottom line. In Q2, its profit margin was an outstanding 55%. There's not a lot to nitpick there; Palantir is a dominant and rapidly growing AI company that produces a ton of profits.
But what might its future look like?
Rapid future growth is already baked in
For several years, analysts' forecasts and Palantir's own guidance have projected that the company's growth rate would slow each quarter. But it never has.
PLTR Revenue (Quarterly YoY Growth) data by YCharts.
As demand for AI systems ramps up and its client base comes to recognize the potential of its products, it's possible that Palantir will continue to grow at a rapid pace. Still, it will eventually find a top somewhere along the way, likely in the next three years.
The problem I have with Palantir's stock is its valuation. There are relatively few businesses growing as fast and as profitably as Palantir is, so comparing it to other businesses from a historical standpoint isn't easy. If we arbitrarily say that it should carry a final trailing earnings multiple of 35 times earnings -- a high premium, but not an unreasonable one for a dominant business -- Palantir would still have a lot of work to do to achieve the earnings required to support that multiple. Palantir currently trades at 159 times earnings.
PLTR PE Ratio data by YCharts.
For this stock to reach 35 times earnings, Palantir must increase its profits by over 350% -- and its share price would have to stay flat while it did that. If both of those things happen, then Palantir's stock will have a reasonable valuation.
If we assume Palantir's profit margin remains unchanged over the next three years, its revenue would need to grow at a compound annual rate of 52%. That's a high bar, but probably not unreasonable for a company with its offerings to achieve at the peak of the AI boom.
With all that in mind, I think Palantir's stock will disappoint and underperform over the next three years due to how much anticipated growth is baked into its stock price already.
However, if Palantir continues to defy expectations and does something like double its revenue each year over the next three years, then it would be a no-brainer buy at today's prices, as the company would produce enough growth in the next two years to lower its valuation to the 35 P/E ratio target. A double in year three would send the stock soaring.
It all depends on how hot Palantir's business growth stays. If it's red hot, then the stock could prove a great buy. If that growth pace slips at all, then the stock could be a dud.