Should You Own This Cathie Wood Favorite? A Look at Palantir Technologies Stock.

Cathie Wood doesn't shy away from taking risks. It's part of what has garnered her a loyal following of investors who like her bold style. Her flagship fund's 152.8% return in 2020 probably helped, too.

Of course, risk-taking often comes with downsides. The same fund, the ARK Innovation ETF, is still down more than 60% since its 2021 peak, while the S&P 500 is up nearly 45%. Still, many continue to look to Wood as a luminary of innovation investing.

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Wood recently took to social media platform X to tell her followers that she believes the CEO of one of her largest holdings when he says his company will become the largest pure-play enterprise artificial intelligence (AI) software company in the world. That company, Palantir Technologies (NASDAQ: PLTR), also happens to be one of the hottest stocks on Wall Street.

So, should you own this favorite stock of Cathie Wood?

Palantir's core business is thriving

The company, which helps organizations leverage AI to improve decision-making in real time, is executing at a very high level. There's no doubt about that. Clients as diverse as Ferrari and the U.S. Army count on its advanced technologies.

This utility has driven consistent revenue and earnings growth. The chart below shows how strong its growth has been on the top line (revenue) -- and especially on its bottom line (earnings).

PLTR EPS Diluted (TTM) data by YCharts; TTM = trailing 12 months.

Palantir has a unique and powerful approach

The magic is in both the uber-advanced technology itself and the company's ability to adapt it in a unique manner to each of its clients. This isn't a one-size-fits-all approach, and it's part of why its AI solutions can take on such complex problems.

The company sends what it calls its "forward deployed software engineers" to work with its clients to create a bespoke solution that starts with a deep understanding of the real problems.

Note the military flavor of Palantir's terminology here. If "forward deployed" wasn't clear enough, they're also called "deltas," apparently in reference to U.S. Army elite special operatives.

The company deliberately fosters a sense that they are "in the trenches," at war with the issues its clients face -- and to be sure, that's often literally true as Palantir counts as clients five branches of the U.S. armed forces.

Image source: Getty Images.

This relationship, aside from delivering incredibly effective and responsive results for the clients, makes Palantir's services sticky -- that is, there is a high cost to switching to a competitor. From the incredible level to which its systems are integrated with its clients' systems, to the psychological bonds forged having its deltas "forward deployed," the decision to sever ties with Palantir is likely not one made lightly.

Palantir can only outrun its valuation for so long

This is nothing new for investors who have followed the company at all, but the fact is that the stock is incredibly expensive. The price-to-earnings ratio (P/E) currently sits just shy of 560. Its price-to-sales ratio (P/E) is 102. These are astronomical. This table below compares these current figures to Nvidia's and Cisco's at their peaks.

You might be thinking that Palantir's growth justifies these inflated numbers, at least for a time. Perhaps, but consider that its sales growth right now is only about 66% of Cisco's at its peak, and its earnings growth is slower than Nvidia's current growth, which in turn is much less than it was during its peak.

There is just no way to square this circle. Palantir's valuation is wildly out of proportion, and that makes it a ticking time bomb. There is no doubt that it is operating at an extremely high level, but this sort of valuation requires perfection, something no company can deliver. I would say that unless the stock falls significantly -- let's say, 50% -- I would not consider owning it, regardless of what Cathie Wood thinks of it.

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Johnny Rice has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Cisco Systems, Nvidia, and Palantir Technologies. The Motley Fool has a disclosure policy.