Should You Buy Palantir Stock Below $125? Here's My Honest Take.

There have been massive gyrations in the stock market this year, despite the S&P 500 index still sitting close to all-time highs. For example, previously soaring Palantir Technologies (NASDAQ: PLTR) is down 41% from its highs, entering a deep drawdown and recently falling below $125.

The artificial intelligence (AI) software analytics platform continues to grow its business at an impressive clip, with solid margin expansion. Does that mean you should buy the dip in the stock today at these cheaper levels? The answer is clear when you look at the numbers.

Fast growth and surging profits

Through the software it provides to the United States government and large businesses, Palantir has become a massive revenue driver in recent years. It is one of the premier deployers of AI software for enterprises, and today, every executive suite wants to accelerate into the AI age.

Image source: Getty Images.

Last quarter, its overall revenue grew 85% year over year to $1.6 billion, with 104% growth in the United States. At the same time, its GAAP (generally accepted accounting principles) operating income was $754 million, for a profit margin of 46%. This makes it one of the most profitable software providers in the entire world.

Palantir reports its upcoming earnings on Monday, Aug. 3. Depending on when you read this article, the results may already be out. Investors will be expecting continued growth, with consensus estimates calling for 80% year-over-year revenue growth.

A valuation that is still at a premium

With Palantir stock down 41% from its highs, readers may think that it now trades at a low valuation. While the stock is certainly cheaper than before, it is still objectively at a premium on any valuation metric.

As of this writing, Palantir shares trade at a price-to-sales (P/S) of 60, which is significantly above the S&P 500 index average of 3.5. It has a price-to-earnings ratio (P/E) of 138, also well above the index average of around 22. This means there are still significant expectations of further growth embedded in the stock price.

There is also the headwind of shareholder dilution to deal with. Palantir's shares outstanding are up 20% in the last five years, and investors should probably expect a similar growth rate in the years ahead.

PLTR data by YCharts

Should you buy Palantir stock today?

Rapid revenue growth has driven massive gains in Palantir's share price in the last five years. The stock price is up 463% over that time frame, even after this recent drawdown, while revenue is up 265% cumulatively.

In order to believe Palantir is a good stock to buy at these prices, you need to expect these high levels of revenue growth to continue. For example, let's look at its trailing revenue of $5.22 billion versus the current market cap of $292 billion. If Palantir can maintain a 50% average annual revenue growth rate over the next three years, sales will reach $17.6 billion. A 46% profit margin would translate this revenue into $8 billion in earnings, before taxes.

Compare that to its current market cap -- which will keep getting diluted through share-based compensation -- and that is a forward multiple of operating earnings of 36.5. Even in a highly optimistic scenario, Palantir trades at a high forward earnings multiple a few years out.

When the math lines up this way, it is hard to envision a scenario in which Palantir can deliver solid returns for shareholders over the next few years. Don't buy Palantir stock unless it dips significantly from here. It is close to impossible for a stock with this high a P/S ratio and a large market cap to work for investors.

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.