2 Hot AI Stocks to Sell Before They Fall 25%, According to Wall Street Analysts

Key Points

• AI stocks have soared in the last year, making some of them overvalued.

• Palantir has an extreme price-to-sales ratio that makes it a dangerous stock to own.

• BigBear.ai is a struggling business being propped up by an AI narrative.

• 10 stocks we like better than Palantir Technologies ›

Everyone has fallen in love with artificial intelligence (AI) stocks, and for good reason. But that does not mean investors should buy stakes in these companies and ignore valuation, which always matters in the long run.

Plenty of AI stocks have soared by three-figure percentages in the last year. This makes them dangerous to buy if you ignore fundamental analysis.

Where to invest $1,000 right now? Our analyst team just revealed what they believe are the 10 best stocks to buy right now. Continue »

Palantir Technologies (NASDAQ: PLTR) and BigBear.ai (NYSE: BBAI) are two hyped AI stocks that are up big in the last year. Wall Street analysts -- who typically give aggressive price targets -- have consensus targets for both stocks that are 25% below where they trade today. Here's why investors who own Palantir and BigBear.ai should sell right now.

Image source: Getty Images.

Palantir's extreme valuation

Palantir is one of the fastest growing software and AI businesses in the world. It works with governments, large organizations, and big businesses to organize and analyze reams of data using AI. This has led to some tremendous growth.

Last quarter, its total revenue rose 39% year over year to $884 million. U.S. revenue grew 55%, while U.S. commercial revenue grew an astonishing 71% year over year, which shows how fast AI applications are growing in this country. Palantir is also highly profitable, generating 20% operating margins last quarter, or $176 million in operating income.

Investors have fallen in love with the stock. It's up almost 400% in the last 12 months, crushing the market averages and making shareholders wealthier. Today, it trades at a market cap of $317 billion, making it one of the largest companies in the world by market capitalization.

Wall Street is now cautious about Palantir's prospects, with a price target of $107.90 compared to the current share price (at the time of this writing) of around $135. I believe the downside may be even more severe in the years to come. Palantir's stock trades at a price-to-sales ratio (P/S) of 107, which puts unsustainable expectations on the future growth of the business.

Why? Let's do some quick math to illustrate. The company's trailing revenue is $3.11 billion. Even if it can multiply its revenue tenfold over the next 10 years -- a scenario that is unlikely unless you are extremely optimistic about its prospects -- it will be doing around $31 billion in revenue a decade from now.

If Palantir generates 30% profit margins in 10 years, that will equate to around $10 billion in annual earnings, or a price-to-earnings ratio (P/E) above 30 compared to the current market cap (P/E takes market cap and divides by earnings).

This makes the shares extremely overvalued. Even if the most optimistic growth scenario plays out, the stock will likely not be much higher in 10 years' time. Sell it at its P/S ratio above 100.

BBAI PS ratio, data by YCharts.

Burning cash flow and low growth

With AI in its name, BigBear.ai has been a thematic stock for investors. It is up even more than Palantir in the last year, for a 441% gain for shareholders at the time of this writing. Analysts have a consensus price target of $5.83 compared to its present price of $7.75.

The company offers AI-powered decision guidance for businesses. That is eerily similar to Palantir and is something that investors are falling head over heels to put into their portfolios today.

With a P/S of 12, BigBear.ai is not nearly as extreme as Palantir at 107. However, the business looks a lot weaker than its competitor.

Revenue growth is slow. Last quarter, sales increased only 5% to $34.8 million. Margins are weak: Gross margin is only 21.3% compared to the typical software/digital company above 50% or more. Free cash flow was a negative $42 million over the last 12 months and has never been positive.

BigBear.ai is barely growing even during a time when the AI industry is expanding like gangbusters. This indicates to me that the company is not a leader in its space and is struggling versus the competition. Combined with low profit margins and negative free cash flow, it's a sell after its meteoric rise in the last 12 months.

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Brett Schafer has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Palantir Technologies. The Motley Fool has a disclosure policy.