"Pentagon's 'Cut off Supply' Triggers Selling Wave, Palantir's High Valuation Raises Market Doubts"

Noticeably, the sharp drop in Palantir (PLTR.US) stock price last week did not convince skeptics that the stock suddenly became a bargain. Earlier, there were reports that the US Secretary of Defense, Hagel, plans to cut projected US military spending by 8% over the next five years, which could jeopardize a major source of the company's revenue, leading to the largest three-day drop in the stock since 2022. Although some investors speculated that Palantir might eventually emerge as a winner in the Pentagon's streamlining measures, this news triggered a sell-off in the stock of the technology industry's most expensive company. Capwealth Advisors Chief Investment Officer Tim Pagliara said, "While the current P/E ratio is slightly more realistic, I do not think its value is high, and there still exist significant execution risks and uncertainties. It is difficult to predict growth until we know what the military budget will look like." Palantir faces its worst three-day decline since 2022 This data analytics software company is one of the biggest winners in the AI boom, with its stock price rising over 300% in the past year and its market value increasing by nearly $190 billion. However, Palantir stands out among tech companies because a large portion of its revenue comes from the US government. With President Donald Trump promising to cut federal spending, factors that were originally favorable to the stock suddenly became major risks. Hagel set February 24 as the deadline for feedback on the proposed reduction measures, meaning investors may soon have a clearer understanding of the impact on Palantir and defense contractors. Data shows that over 40% of Palantir's 2024 revenue is related to the US government, with this portion growing over 40% in each of the past two quarters. Bloomberg research indicates that this risk exposure is not common, with most software peers of the company typically in the mid-to-high teens in terms of this ratio. Military spending is especially important, with William Blair analyst Louie DiPalma estimating that 22% of Palantir's government revenue comes from the US Army. It is worth noting that the stock has high volatility. Last month, the stock saw even larger declines, setting the stage for a record high close on Tuesday before news of the spending cuts plan emerged. Jack Ablin, Chief Investment Officer of Cresset Wealth Advisors who holds the stock, said, "If someone is looking for an excuse to take profit, such titles are definitely the best choice." He said, "The government may scrutinize all spending, and I think suppliers like Palantir may continue to get business and may even expand it." Palantir remains one of the top performers among the Nasdaq 100 index stocks this year, with a gain of around 34%. The company had previously seen its stock rise earlier this month due to strong revenue forecasts. The company stated that its AI software is experiencing "unstoppable organic growth." Some analysts say that the tailwind of AI reduces the risks related to government budgets. Wedbush gave the company an "outperform" rating, stating that "Palantir's unique software approach will enable the company to obtain more IT budget from the Pentagon," and that cuts "will eventually become a positive growth catalyst." Last week, amid the sell-off, Wall Street did not show panic, with market expectations for the company's profitability and revenue generally rising. However, it is undeniable that the company's valuation remains too high, which exposes it to risks. The company's price-to-earnings ratio is close to 180 times, making it the most expensive component of the S&P 500 information technology sector, almost twice that of the second-ranked Crowdstrike Holdings Inc. The P/E ratio of the entire information technology sector is less than 30. High valuation is often cited as a problem, with over half of the analysts tracked by Bloomberg giving the stock a rating equivalent to hold, with six recommending buying and five recommending selling. The stock is about 8% higher than the 12-month average target price, making it one of the worst-performing stocks in the tech sector in terms of expected returns. Nevertheless, Pagliara of Capwealth Advisors, who holds the stock, emphasized his confidence in Palantir's long-term potential at the Pentagon. "An army focused on efficiency and adaptability will invest more in technology and AI, so Palantir is likely to go against the trend of budget cuts," he said. "I am not worried like I am about a company that makes tanks."