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Palantir Technologies (NYSE: PLTR) rose to the top as one of the premier artificial intelligence (AI) stocks. Its prowess in AI software application is almost unmatched, which is why investors are so excited.

However, alongside this excitement has come inflated expectations, and I’m worried that even if the business succeeds, the stock could fall flat on its face due to the run-up it already experienced.

Can Palantir live up to these high expectations? Or are investors in for a rude awakening?

Palantir’s software is just starting to be adopted

Palantir’s software has been integrating AI with decision-making for a long time. It started in 2003 as a company focused on providing software to the government and has since expanded into the commercial sector. Its software was developed to streamline data flows and give decision makers the best possible information.

This program is incredibly useful, especially in high-stakes scenarios (like those found in government). And Palantir’s latest product takes this to a whole new level.

Its Artificial Intelligence Platform (AIP) gives developers the tools to integrate AI throughout a business, whether it be in apps for certain purposes or using AI to drive workflows and improve productivity.

This is exactly what many companies are looking for because AI is mostly being used as a tool on the side rather than directly integrated into workflows.

AIP has been a hit on the U.S. commercial side of the business, driving a second-quarter revenue increase of 55% to $159 million among these clients. Perhaps even more impressive was that its U.S. commercial customer count rose 83% from a year ago to 295.

This shows that there have been relatively few adapters of Palantir’s software, but there’s a reason for that: its cost. If we annualize the revenue and divide it by customer count, that gives an annual contract value of around $2.16 million. That’s a very expensive software package, and it limits potential clientele.

Still, that’s only a fraction of Palantir’s business. Its total second-quarter revenue was $678 million, up 27% from last year.

Although Palantir is a growing software company, it still knows how to turn a profit (a lesson it can teach some of its peers). The second quarter saw record profit margins, with earnings per share totaling $0.06.

But all of those great metrics come at a hefty price, which is why I’m not keen on buying Palantir’s stock right now.

Even if the business succeeds, the stock could struggle

Palantir is still working on achieving maximum profitability, so using an earnings-based valuation metric doesn’t do it justice. (The stock trades at 86 times forward earnings.)

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Instead, it’s better to project what Palantir’s valuation could be if it achieved margins similar to those of other mature software companies. Adobe is the industry standard for software companies, and its average profit margin over the past five years was 30%.

We need to establish a growth rate for the business. Wall Street analysts expect 24% growth in 2024 and 21% in 2025, but if we give Palantir the benefit of the doubt and say it can maintain its second-quarter growth rate of 27% for five years, that would give it annual revenue of $8.19 billion.

If it converts 30% of that into net income, it would generate $2.46 billion in profits. We get its ratio of price to five-year forward earnings by dividing its current market cap by this hypothetical profit.

This figure comes in at 27.8 times five-year forward earnings. What does Adobe trade for right now? It’s at 31.4 times forward earnings.

So Palantir must greatly exceed Wall Street expectations and achieve industry-leading profit margins for five years, and only then will it be valued at the same price another company is right now.

This just shows the extreme expectations built into the stock, which is why I’m not a buyer at these prices. There are too many other companies’ shares that can be bought for a reasonable price to justify buying Palantir right now, even if the underlying business will succeed over the same time period.

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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.

Can Palantir’s Stock Live Up to Lofty Expectations? was originally published by The Motley Fool

During a Berkshire Hathaway shareholder meeting a few years ago, Warren Buffett and Charlie Munger were asked a straightforward yet revealing question: If someone in your local town owned three to five businesses, such as a cake shop and a dry cleaner, you’d probably think they were pretty well diversified. So why do financial experts often recommend holding 20 to 30 stocks in a portfolio? The questioner was curious about Buffett’s views on diversification and how he approaches concentrating his investments.

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Buffett didn’t hesitate to challenge the conventional wisdom. He made it clear that while owning a broad range of stocks is often recommended, it’s more of a safety net for those who don’t know how to evaluate businesses properly. “Diversification is a protection against ignorance,” Buffett said. “If you know how to analyze businesses and value businesses, it’s crazy to own 50 stocks or 40 stocks or 30 stocks.” In other words, if you’ve done your homework and truly understand a few outstanding companies, spreading your bets across dozens of stocks might dilute your returns.

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Buffett isn’t just speaking theoretically. He practices what he preaches. At one point, he mentioned that he owns just one stock in his portfolio – the one he knows best. And when it comes to Berkshire Hathaway, he’s perfectly comfortable with concentrating investments in just a few stellar businesses. “I could pick out three of our businesses, and I would be very happy if they were the only businesses we owned and I had all my money in Berkshire,” he added.

Then Charlie Munger, never one to shy away from a blunt opinion, chimed in. He didn’t just challenge modern financial theories; he flat-out dismissed them. “Much of what is taught in modern corporate finance courses is twaddle,” Munger declared, eliciting laughter from the crowd. His point? Complex models and theories might sound impressive but often add little value to real-world investing.

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Munger also emphasized the importance of sticking with what you know. “If you find three wonderful businesses in your life, you’ll get very rich,” he said. And unlike the intricate theories taught in finance classes, this approach is simple, straightforward, and, according to Munger, far more effective.

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Buffett and Munger’s advice is clear: If you truly understand the businesses you’re investing in, you don’t need to spread your money across dozens of stocks. Instead, concentrate on a few outstanding companies that you know inside and out. Diversification can help you avoid major mistakes, but it might also prevent you from achieving the extraordinary results of deep, focused investments in just a few high-quality businesses.

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So, the next time you’re building your portfolio, remember Buffett and Munger’s wisdom. Don’t let the fear of risk lead you to dilute your potential returns. Instead, focus on finding those few great companies you understand and believe in – and then, as Munger might say, ignore the twaddle.

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This article Want to Get ‘Very Rich’? Charlie Munger and Warren Buffett Say You Only Need 3 Wonderful Businesses – Not 30 Stocks originally appeared on Benzinga.com

© 2024 Benzinga.com. Benzinga does not provide investment advice. All rights reserved.

Palantir Technologies (NYSE: PLTR) is quickly becoming the go-to provider of artificial intelligence (AI) software platforms for companies and governments around the globe. Evidence of this can be seen in the recent acceleration in the company’s growth as well as its improving revenue pipeline. Both metrics point toward better times ahead.

Investors are noticing and have been buying Palantir stock hand over fist. The stock is up an impressive 76% so far in 2024, and the following discussion offers clues as to why that has been the case.

Palantir’s AI software platform has gained impressive traction

When Palantir released its second-quarter results last month, the company reported a year-over-year increase of 27% in revenue to $678 million. That was a solid improvement over the 13% year-over-year growth the company delivered in the same period last year, as well as an acceleration over its Q1 revenue growth of 21%.

There was a nice jump in the company’s customer base, as well as the size of the deals that it has been striking with customers. Palantir management credited its improving growth profile to the growing adoption of its Artificial Intelligence Platform (AIP). This is a software platform that helps enterprises and governments integrate generative AI into their processes to help improve operational efficiency.

From helping customers build their own large language model (LLM)-powered applications to helping them accelerate their daily workflows with the help of generative AI, the usefulness of Palantir’s AIP seems to have struck a chord with customers. This explains why the company raised its 2024 revenue growth forecast and expects its top line to increase by 24% this year to $2.75 billion.

More importantly, Palantir seems capable of sustaining its outstanding growth in the long term, considering that it ended the previous quarter with $4.3 billion in remaining deal value (RDV). The metric refers to the total remaining value of Palantir’s contracts at the end of a period, and it rose 26% year over year in Q2.

This AI hardware giant is making strides in the AI software market

So, Palantir seems well on its way to making the most of the huge end-market opportunity available in the generative AI software market. However, there is another way for investors to capitalize on the booming demand for AI software, and a closer look could lead investors to think that it may be a better AI software stock than Palantir.

Nvidia (NASDAQ: NVDA) has been the go-to choice for companies looking to purchase high-end AI hardware so that they can train AI models, resulting in outstanding growth in the company’s revenue and earnings in recent months. What’s interesting is that CFO Colette Kress’ comments on the recent earnings conference call suggest that Nvidia is starting to make a dent in the enterprise AI software market as well. According to Kress, “We expect our software, SaaS, and support revenue to approach a $2 billion annual run rate exiting this year, with Nvidia AI Enterprise notably contributing to growth.”

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CEO Jensen Huang also commented, pointing out that customers can deploy Nvidia AI Enterprise software for $4,500 per graphics processing unit (GPU) per year. Given that Nvidia’s AI GPUs are priced at $30,000 or more for a single chip depending on the configuration, enterprise customers looking to build and deploy AI models are getting a good deal through Nvidia’s AI software platform.

Nvidia provides customers with multiple AI software offerings. For example, the company’s AI Foundry platform, which was launched in July this year, is an end-to-end solution with which customers can build and deploy custom generative AI models. Nvidia offers popular foundation models that can be tweaked by its customers and quickly move AI applications (including chatbots, content creation tools, and document processing tools) into the production phase.

Nvidia also provides pretrained customizable AI workflows that can be used for extracting data from PDFs or deployed for creating customer service workflows, accelerating drug discovery in the field of medicine, or building custom generative AI apps suited to an organization’s needs. What’s worth noting is that the adoption of Nvidia’s software solutions is increasing at a terrific pace thanks to AI.

In its February earnings conference call, Nvidia management pointed out that its software and services offerings reached an annual revenue run rate of $1 billion in the fourth quarter of fiscal 2024. So, the company’s software and services revenue run rate is set to double in the space of just one year. That’s significantly faster than the pace at which Palantir’s top line is set to grow this year.

Throw in the fact that Nvidia benefits big time from the booming demand for its AI chips, which led to 122% year-over-year growth in the company’s revenue in the second quarter of fiscal 2025 to $30 billion, and it is easy to see that the chipmaker is the more diversified play on AI. Another point worth noting here is that Nvidia stock trades at 28 times sales, which is lower than Palantir’s sales multiple of 29.

What’s more, Nvidia is the more attractive AI stock when we compare the earnings multiples of both companies.

So, investors looking for a cheaper alternative to Palantir to take advantage of the AI software market’s growth would do well to take a closer look at Nvidia, especially considering that the latter already has a flourishing AI hardware business that makes it a better growth stock to buy right now.

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

Meet the Artificial Intelligence (AI) Stock That Could Become the Next Palantir, or Even Better was originally published by The Motley Fool