Why the large discrepancy? It has to deal with valuation.

While Palantir may be growing faster than Adobe, the price you must pay for that growth is too high for many investors.

Palantir currently trades for an unbelievable 41.1 times sales. For comparison, Adobe trades for 41.6 times its earnings. That’s a huge discrepancy, as investors care about earnings once a company fully matures.

To illustrate how expensive Palantir is, let’s calculate how much growth it would need to reach Adobe’s valuation.

In Q2, Palantir grew its revenue at a 27% pace, and management expects to grow Q3 revenue by 25%. But for argument’s sake, let’s say it can grow between those two projections (26%) for five years. That’s probably longer sustained growth than Palantir can put up (Wall Street thinks it will grow revenue at a 21% pace in 2025), but it’s what’s required to get the outcome the stock is priced for.

Furthermore, let’s say that Palantir can improve its profit margin from its current 20% level to Adobe’s 30% level. That’s a much more reasonable projection, as Palantir has steadily improved its margins over the past few quarters.

If it does both things, Palantir’s stock would generate $2.36 billion in profits five years from now, giving it a 40.7 times trailing earnings valuation.

That’s with zero change in today’s stock price. So if you think Palantir will be a better stock to own over the next five years, Adobe’s price would have to go down.

I think that’s a terrible bet, as Adobe has shown a knack for consistently growing at the mid-teens pace each year.

Owning Palantir instead of Adobe doesn’t make a lot of sense, as the expectations baked into the stock are outrageous. Although Palantir is a flashy AI stock, you’d be better off owning the stalwart that continues its steady, market-beating trajectory year after year.

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Keithen Drury has positions in Adobe. The Motley Fool has positions in and recommends Adobe and Palantir Technologies. The Motley Fool has a disclosure policy.

Palantir vs. Adobe: Wall Street Says to Buy One AI Stock and Sell the Other was originally published by The Motley Fool