Distorted realities

I’ve tried to be clear that nothing written here should be construed as individual investing advice. It is merely me journaling my thoughts at any given moment. And my thoughts are often wrong, or at least incomplete. Use this for educational, and if I am lucky, entertainment purposes. Don’t run out and buy or sell stocks after reading this.

Any regular reader knows I have complicated feelings on Palantir. The company’s software is uniquely powerful and has a definite use case for both government and commercial customers. Yet the stock tends to do silly things. And if Palantir manages to get the government/commercial balance correct they will be in rare company.

Palantir shares are up 345% over the past 12 months, as of this writing, and up 38% in the first seven weeks of 2025. But in the last few days the shares have lost about 20% of their value. Part of it was CEO Alex Karp announcing a new share sale plan (which I’ll admit does feel like trying to take advantage of the gains, but also, he still has plenty of stock and should have every reason to keep working to get the share price higher).

The other big thing pressuring the stock is the White House’s efficiency effort has turned its attention to the Pentagon, pushing for 8% annual defense spending cuts over the next five years.

We’ll get to Palantir in a second, but first a few quick thoughts about this so-called Pentagon cutting plan. At face value, it would mean reducing the DoD budget from $850 billion last year to about $624 billion in five years. That’s huge. And after the last few weeks, I refuse to say it is impossible. But there are some reasons for defense investors not to freak out. Consider:

• The president and vice president have both said the U.S. needs to spend more, not less, on defense. In fact, President Trump has signaled he would like NATO to increase defense spending to 5% of GDP. The U.S. GDP in 2023 was $27.7 trillion. 5% of that would be $1.3 trillion, significantly more than $850 billion. I don’t expect spending to go anywhere near $1.3 trillion, but at times of competing rhetoric it is best not to take any one statement as gospel.

• Procurement is only about 20% of defense spending. The rest of it is salaries, fixed costs, real estate, etc.

• We’ve depleted an estimated one-third of our weapons stockpile in the last five years. Which means the U.S. needs to spend just to remain flat from five years ago. There are no overages right now in key weapons systems.

Specific to Palantir: To any extent that the recent selloff is tied to the Pentagon headlines, it is stupid. Period.

Palantir posted government revenue of $343 million in the most recent quarter. Annualized, that is still less than 1% of the government’s budget. Even in a world where there is an across-the-board 8% haircut everywhere (which won’t happen) you still only need less than $30 million in commercial growth to offset.

By definition, the markets believe commercial will grow by much more than $30 million each quarter for the foreseeable future. And that brings us to the bigger issue.

I and other skeptics of Palantir’s valuation have been pretty consistent over the years: Government business cannot and will not justify that valuation. Valuation metrics are terrible and these are particularly bad but they make the point: Palantir a few weeks ago traded for 75 times expected 2025 sales, now about 65 times. 160 times expected earnings (adjusted for debt), down from about 175 times. The entire U.S. government grows at a couple of percentage points annually, and for as good as Palantir’s software is it isn’t a replacement for nuclear submarines, missiles, and soldiers. The Pentagon won’t just substitute out carriers to buy more software. Marketshare gains inside the Pentagon are limited.

There is no bull out there who can honestly argue that Palantir can grow its defense business into the valuation that the market has given it.

It has to be about commercial. It is the only way Palantir could ever possibly make sense. And given the elevated valuation, it is going to take substantial growth on commercial. Something probably beyond the 40% annualized rate management was talking about a few years ago during the IPO road show.

Here’s the truth: For Palantir bulls to be correct, defense has to become irrelevant. The only way Palantir grows into its current valuation would require commercial sales to dwarf government sooner rather than later. And in that world, an 8% haircut to that much smaller defense business would not move the needle on overall sales or profitability.

So, I have good news for Palantir longs who are worried about the potential impact of Pentagon cuts to the long-term business outlook. There is no need to worry. Whether Palantir shareholders realize it or not, they have been betting that defense is an afterthought as they have bid the stock up over the last year. And therefore, yes, this Pentagon-related selloff is overdone.

Can the commercial side do it? We’ll have to see. The software is impressive and could evolve into a lot of useful things for a lot of different customers. If so, today’s $250 billion market cap might look cheap.

Or, potentially, the valuation hasn’t been tied to any reasonable expectation for reality for some time now.

We’ll see.

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