Buying the Dip on Palantir Stock? Read This First

Key Points

Palantir's business is firing on all cylinders.

Forward stock dilution will be a headwind for shareholders.

Palantir's stock is at a much higher valuation than that of any other large-cap technology player.

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The adage among investors these days is to "buy the dip" whenever stocks head into a bear market. This tactic can work in certain circumstances, but it's a dangerous game to play with hypergrowth stocks trading at extreme valuations. Sometimes, these types of stocks can not only fall 20%, but also another 80% or more in a downturn.

Palantir Technologies (NASDAQ: PLTR) has the potential to be one, for instance. Palantir shares have fallen 34.5% from all-time highs, but according to some valuation metrics, it is still by far the most expensive large-cap technology stock investors can buy right now.

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Before buying the dip on Palantir, read this first. It might just change your mind.

Fast growth, but a limited market opportunity

It's undeniable that Palantir is growing quickly. Revenue was up 70% year over year last quarter to $1.41 billion, with accelerating growth over the last few years as the company captures opportunities enabled by its artificial intelligence (AI) software for enterprises. U.S. commercial revenue grew an astonishing 137% year over year last quarter, with numerous new contracts signed to boost the company's backlog.

This puts Palantir in a solid spot as a business. It has gotten well past the questions a few years ago about the viability of its business model and is now reporting a GAAP (generally accepted accounting principles) margin of 41% as of last quarter.

Where the company may run into a growth ceiling is the limited addressable market for enterprise analytics software. Any software company that has grown into the tens of billions in annual revenue -- such as Adobe or Salesforce -- has built or acquired its way into multiple market verticals. Palantir currently serves one niche in using AI to parse data for analytical capabilities. If it is to grow significantly from its current annual revenue of $4.5 billion, it will need to take on the risk of venturing outside its core competency.

A headwind little discussed by investors

What can sneak up on a stock like Palantir -- especially after being a big winner in the last few years -- is the headwind of stock-based compensation. It's a silent, non-cash killer of shareholder returns.

Without going into complicated shareholder dilution math, we can look at Palantir's shares outstanding growth over the last five years: 28%. If this level of dilution continues, Palantir's current market cap of $316 billion will grow to $404 billion over the next five years, if the stock price stays exactly where it is today. That is close to $100 billion (almost 25x the company's 2025 revenue) from just shareholder dilution.

Unless the company radically changes its employee compensation plan, Palantir stock is likely to face shareholder dilution headwinds for any investor planning to hold for the long haul.

Why you should not buy the dip on Palantir stock (yet)

This all leads into what matters above all else for Palantir dip buyers: Valuation. Palantir is a great business, and one that is growing quickly. But it is still valued at an extreme premium versus other large technology players.

We can look at one simple valuation metric to hammer home this point: The price-to-sales ratio (P/S). It measures market cap versus trailing revenue, and while it is not the end-all, be-all, the ratio is a great spot to start when evaluating a hypergrowth stock.

Palantir has a trailing P/S ratio of 68. There is only one other company with a market cap above $100 billion and a P/S ratio above 30 (Arm Holdings' P/S is currently around 36). That puts Palantir in rarified air when it comes to premium valuations. Even if Palantir miraculously grows to tens of billions in revenue in the years to come, investors will be disappointed in the forward returns due to simple valuation math.

Wait for further dips before buying Palantir. Your portfolio will thank you a decade from now.

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Brett Schafer has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Adobe, Palantir Technologies, and Salesforce. The Motley Fool recommends the following options: long January 2028 $330 calls on Adobe and short January 2028 $340 calls on Adobe. The Motley Fool has a disclosure policy.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.