Unparalleled Overvaluation of Mega-Cap Stocks in My 27-Year Investing History
In the dynamic world of tech stocks, Palantir Technologies (PLTR) has been making headlines with its substantial growth. However, concerns about its high valuation and potential for a correction are growing, drawing parallels to the overvalued megacap stocks of the late 1990s and early 2000s during the dot-com bubble.
Historical examples of overvalued megacap stocks with extremely high Price-to-Sales (P/S) ratios are most prominently found during the dot-com bubble. During this period, technology companies with little to no profits were valued at extremely high multiples of their sales, leading to unsustainable stock prices. This bubble ended with a severe crash, exemplified by the Nasdaq Composite losing about 78% from its peak in March 2000 over the following three years.
Key characteristics of these overvalued megacaps historically and today include extremely high P/S ratios driven by market enthusiasm for new technology sectors, concentration of market capitalization in a few tech giants, and following a peak in overvaluation, valuations collapsed sharply, resulting in massive drawdowns.
In the present context, some of today’s mega-cap tech stocks, such as Nvidia, Microsoft, and Meta, have shown very high valuations, often trading at P/S multiples that echo those seen in the late 1990s. Although these firms have stronger earnings today compared to the dot-com era, the market still exhibits a high degree of concentration and overvaluation risk.
Palantir Technologies, an AI-data-mining specialist with a market cap of over $352 billion, is one such company that has attracted investor attention. Its TTM P/S ratio stands at 119, making it the priciest megacap stock of the century.
Palantir's two operating segments, Gotham and Foundry, have a sustainable moat and generate predictable annual sales and operating cash flow. Gotham is an AI- and machine learning-fueled software-as-a-service platform that assists with military mission planning and execution. Palantir has consistently maintained an annual sales growth rate in the 25% to 35% range.
However, Palantir's ascent from a $15 billion market cap at the end of 2022 to a $352 billion market cap was due to investor excitement about the company's sustainable moat, growth rate, and ideal positioning under the Donald Trump administration. This rapid growth has led to a high valuation, which some investors find concerning.
Moreover, Palantir's stock is valued at four times this line-in-the-sand level. The company's reliance on interest earned from its cash reserves for 40% of its pre-tax income in 2024 is also a point of contention, as this isn't innovative or sustainable.
The midterm elections in 18 months have the potential to shake-up Congress, affecting defense spending, which is a significant portion of Palantir's revenue. There's not much clarity on defense spending beyond the next six quarters, adding to the uncertainty surrounding Palantir's future growth prospects.
In conclusion, while Palantir Technologies has demonstrated impressive growth and a strong position in the market, its high valuation and reliance on non-innovative sources of income make it a potential candidate for a correction. Investors should approach Palantir with caution, considering the historical precedent of overvalued megacap stocks and the current market conditions.
- The high valuation of Palantir Technologies, an AI-data-mining specialist, resembles the overvalued megacap stocks during the dot-com bubble, as it trades at a TTM P/S ratio of 119, the priciest megacap stock of the century.
- Similar to the overvalued megacap stocks historically and today, Palantir's market capitalization is highly concentrated, and concerns about its potential for a correction are growing, considering its reliance on interest earned from cash reserves for a significant portion of its pre-tax income.
- In the realm of finance and investing, the potential risks associated with overvalued megacap stocks, like Palantir, underscore the importance of careful investment strategies, as historical examples have highlighted the unsustainable stock prices and subsequent severe crashes that can occur.
