A 35% Dip Is Here for Palantir Stock. Here's Why It's Not Time to Buy -- Yet.

Investor sentiment can be a funny thing. When stocks are deemed part of a winning theme, they can take off like wildfire, and their growth can greatly outpace their fundamentals.

Palantir Technologies (NASDAQ: PLTR) is a perfect example. The stock has been viewed as a winner in the artificial intelligence (AI) and defense spaces, and from where they traded as the start of 2023, its shares rose by more than 3,000% at one point late last year.

Now, though, cracks have begun to form in this bull market, and Palantir stock is down 35% from its all-time high. Yet it remains one of the most expensive stocks in the world, if not the most expensive. Here's why you should still hold off on buying the dip on this AI stock.

Strong growth and increasing margins

Palantir is one of the leading software analytics companies. Acting almost like a consulting firm, the company uses its software to parse data for its government and big enterprise clients and provide them with useful insights from it.

In recent years, the company has deployed its Artificial Intelligence Platform (AIP), which helps organizations securely deploy AI. An individual may be able to use a tool like ChatGPT, but the military and large enterprises must be more cautious about security when making their data available to an AI tool.

Its expansion has coincided neatly with the boom in AI demand, and the result has been strong growth from Palantir. Last quarter, its overall revenue grew 70% year over year to $1.4 billion, with 93% growth in the U.S. and 137% growth from U.S. commercial customers.

Palantir's profit margins have continued to expand, reaching 32% over the last 12 months. This combination has led to a significant profit inflection for the firm, and its stock price has soared.

Image source: Palantir Technologies.

Projecting what the future may hold

The next few years look bright for Palantir because it is signing a ton of deals with the U.S. government and various corporations. The U.S. Army has a contract worth up to $10 billion over 10 years, and the company signed 61 deals worth at least $10 million apiece last quarter alone.

Its remaining deal value for commercial contracts has ballooned to $4.38 billion, giving the company a clear path to keep expanding its revenue. From $4.5 billion in 2025, its annual revenue could easily grow to $10 billion or more in the years ahead.

The problem for Palantir may lie a few years down the road. It is a fast-growing company, but remains a niche software provider (in AI analytics), and its business model is tailored to serving large enterprises and governments.

This limits its total addressable market. There is only so much a business will be willing to spend on AI analytics in a given year. Palantir may expand into other areas to keep revenue growing, but this is not yet a company playing in sectors with revenue opportunities in the hundreds of billions of dollars a year.

Why now is not the time to buy Palantir

Analyzing Palantir's addressable market is crucial for anyone looking to buy the stock right now, because it is still being valued as if it were a burgeoning technology company headed for a $1 trillion market cap.

Right now, its market cap is $315 billion. That gives it a trailing price-to-sales ratio (P/S) of 76 -- an unusually lofty valuation. Even if revenue grows from $4.5 billion today to $20 billion within a few years, with a best-in-class net income margin of 40%, that would yield only $8 billion in net income, giving it a price-to-earnings ratio (P/E) of 39 based on the current market cap.

This level of earnings will not materialize for many years and will require additional shareholder dilution to achieve. Palantir stock remains overvalued even after falling 35% from its highs. As such, I'd advise waiting for further declines before buying any shares.

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.