Is Palantir's Stock in a Bubble? History Says Yes.

There's plenty of evidence that Palantir's (NYSE: PLTR) stock is in a bubble. History is not on Palantir's side, and many companies have traded around the lofty expectation its stock currently trades at, and few (if any) have worked out well for investors.

So, how can one of the most dominant AI software companies be in a bubble when business is booming? It's simple: Expectations outweigh reality.

Palantir's business is succeeding, but it's not the next Nvidia

To be clear, Palantir's business is fantastic and will continue to grow. That part isn't up for debate. Palantir offers a top-notch AI software product that allows its users to make the most informed decisions possible. This benefits governments that deploy its software as well as commercial businesses.

Its Artificial Intelligence Platform (AIP) product is also top-notch. It allows users to integrate generative AI models into a business's inner workings rather than using them as a tool on the side.

But I draw the line at calling Palantir the Nvidia of the software world, as it's in a far too competitive market to have that title.

Nvidia is in a world of its own in terms of performance compared to its peers, so it became the only choice. Palantir has competition from many directions. It's competing against other companies that have pre-built AI models, consulting firms that have the talent to build these models for their clients, and individual contributors that are building these AI models for their own companies.

While Palantir has been successful so far, the number of clients it can sign is fairly limited. Palantir's software is incredibly expensive, mainly because it is purpose-built for each application. In the third quarter, Palantir had 321 U.S. commercial clients, generating $179 million in revenue. If you annualize that revenue figure, you get an average revenue per customer of $2.23 million. This leaves out a lot of potential small and mid-sized clients and caps the maximum customer base Palantir can reach.

This isn't a knock on Palantir or its product; it's just the reality that not every business will use Palantir, whereas something like a Nvidia GPU might be deployed by a vast majority of businesses in one way or another.

However, the stock is trading like Palantir's software will be used by everyone in every business worldwide.

Palantir is trading in a dangerous zone

In the third quarter, Palantir's revenue grew 30% year over year. While that's strong growth, it's not nearly enough to justify the stock price.

Let's take a look at another high-flier that everyone was going to use forever: Zoom Video. Back in the pandemic years, Zoom saw rapid adoption as everyone equipped themselves to work from home. There were predictions that nobody would return to the office, and Zoom would be the new way of doing business. Zoom's revenue rapidly expanded, and so did the stock valuation.

ZM Operating Revenue (Quarterly YoY Growth) data by YCharts

Zoom's revenue quadrupled year over year for a few quarters, but even when revenue was doubling, the stock traded for around 40 to 60 times sales. Once the boom was over, Zoom's stock price collapsed, and it now sits only 15% above where it entered 2020.

Palantir hasn't shown nearly that level of growth, yet its stock trades at a lofty 57 times sales.

PLTR Operating Revenue (Quarterly YoY Growth) data by YCharts

This isn't the first time Palantir has traded around this level, but the last time it did so, it was growing revenue much faster.

As another comparison point, Nvidia never traded for more than 45 times sales, even when its revenue tripled year over year.

Palantir's stock looks to be in a bubble, and investors need to be careful. The problem is that bubbles can go much higher before they burst, and Palantir's stock may continue to rise. However, unless Palantir starts doubling or tripling its revenue year over year and sustains that for a few years, this valuation doesn't make sense.

The company will likely continue to grow and succeed, but over the long term, I doubt the stock will. There are far too many great companies at fair prices in the market that offer greater long-term return potential, and I'd look there (or move profits from Palantir to there) before investing in this stock that's due for a massive drop.

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Keithen Drury has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Nvidia, Palantir Technologies, and Zoom Video Communications. The Motley Fool has a disclosure policy.