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A few years ago, I looked into Palantir (NASDAQ: PLTR). There was some buzz about the company’s tremendous potential, but I did not decide to buy Palantir stock.
Over five years, it has soared 1,576%.
So my decision not to invest means I missed out on some potentially incredible gains.
But, unlike some missed opportunities, I do not regret it.
For one thing, the current valuation of Palantir stock looks ridiculous to me. It is trading on a price-to-earnings (P/E) ratio of 513. Yes, 513!
But there is another reason I do not regret my decision to avoid the company when I first looked at it.
The Warren Buffett approach
The billionaire investor Warren Buffett has often talked about sticking to what you know when investing.
He sometimes phrases it as staying inside one’s ‘circle of competence’. As Buffett sees it, it does not matter how big your circle of competence is – just that you identify it and stay within it.
Why does that matter?
Successful investing is about judging the potential value of a business and investing for less (ideally, much less) than that valuation.
So putting money into a business you do not understand is not really investing, but merely speculation.
A black box
Some of what Palantir does is within my circle of competence. I understand its target market and, broadly speaking, I feel I understand at least some of its product offering.
But, to some extent, the company is a black box for me. That is true now, just as it was true when I first looked at it years ago.
Sure, there are sizeable ongoing sales opportunities to government clients for the sort of data services Palantir offers. But it is not the only company keen to build its presence in that space. What sets it apart? How sustainable is that competitive advantage?
I simply do not know. I can read Palantir’s company accounts like anyone else and get a sense of its dizzying growth. But I still do not really understand whether that growth is based on sustainable competitive advantages or not.
While others may have more insight, I cannot understand to my own satisfaction whether Palantir has a business model that can help it make sizeable profits over the long term.
A possible warning signal?
Meanwhile, that P/E ratio is simply astonishing to me. This is not some tiny company – it has a $376bn market capitalization. Yet it currently sells for over 500 times earnings.
Is that a sign of a frothy market set to stumble?
Not necessarily. One share can easily defy wider market trends. What I see as an overvaluation of Palantir stock does not necessarily mean that the broader stock market is overvalued.
Maybe others who understand the black box of Palantir’s business reckon it really merits that valuation. It has an impressive, sophisticated client base who seem to have heavily bought into its services.
Still, such a valuation seems ridiculous to me. I see it at least as a warning signal. It is a useful reminder for me to stop and think about the valuations of tech firms and shares more generally when considering what to buy or sell this autumn.
