Will these new S&P 500 stocks be sold after a 161% surge?

It was a memorable year for shareholders of the data analytics and artificial intelligence (AI) company. Palantir Technologies (NYSE: PLTR). Over the last year, the company’s shares have increased by over 160%, and the committee selecting companies worthy of membership in the ranking S&P500 added it this month to its benchmark large-cap index. Inclusion in the index is a badge of honor confirming the company’s good results and raising investor awareness about it.

Palantir’s products, especially the AIP platform, are driving accelerating revenue growth and high profitability. However, the share price grew faster than the value of the core business. Should shareholders consider selling now that they have the advantage, or does Palantir have more room to operate?

The shares exceeded the value of the company

I’m not here to pick on Palantir. There’s a lot to be excited about.

The company has become arguably the leading AI software company on Wall Street. It debuted on the AIP platform last year as a tool for companies to develop and deploy custom AI applications, and revenue growth has continued to accelerate since then. Technology consulting company Forrester Research recently recognized AIP as the best AI and machine learning platform on the market.

And yes, its inclusion in the S&P 500 index likely generated momentum for stock purchases. Funds that track the S&P 500 must add Palantir stock to mirror the index, and many investors gravitate toward S&P 500 companies because they must meet strict standards to get into the index.

The problem is that the stock price growth has drastically outpaced the company’s growth. Palantir’s revenues for the last 12 months increased by approximately 16% overall. The share appreciation exceeded this value almost 10 times.

PLTR revenue data (TTM) according to YCharts.

How expensive is Palantir?

In fact, stock prices at any given time largely reflect the market’s level of enthusiasm for that stock. Part of investing is recognizing when the market is too excited or pessimistic.

Right now, market sentiment towards Palanir is extremely crazy.

Remember the “everything bubble” of 2020-2021, when zero interest rates and loose money fiscal policies were introduced to keep the economy stable during the pandemic crisis, resulting in a speculative bubble in growth stocks, cryptocurrencies, and other assets? Even as broad market indexes are once again setting new all-time highs, many growth stocks are still trading at fractions of the valuations they achieved at the height of the bubble.

However, on a price-to-sales (P/S) basis, Palantir is approaching the highest valuations it had during the bubble.

PLTR PS rate data by YCharts.

Analysts believe that the company will generate revenues of $2.76 billion in 2024 and $3.32 billion in 2025. Based on revenue estimates for next year, the company’s stock price is 25. If the stock price eventually stabilizes at a long-term P/S ratio somewhere in the middle of this wide range – say 15 times revenue – its graph may remain flat or decline for years while the company grows enough to catch up with the stock price.

Should investors sell Palantir?

Palantir’s valuation has likely entered bubble territory, and many factors could lead to its burst. As the U.S. election approaches, there is political uncertainty. Geopolitical tensions are growing in Europe and the Middle East. Now that U.S. inflation has largely come under control, the Federal Reserve has begun cutting interest rates, which should stimulate the economy. But when such stimulus is needed, it is sometimes because the country is heading toward a recession.

Stock market bubbles can also burst on their own. Remember that high valuations create high expectations. Palantir’s stock may continue to rise until the company inevitably reaches the impossibly high standards that the market has built into its stock price. When this happens, the correction can be sharp.

In other words, stock market bubbles are like a game of musical chairs. They always end eventually.

For investors, selling winners when they keep winning is difficult, and anyone who has bought Palantir as recently as within the last few months is likely enjoying fantastic gains and feeling good about themselves. However, selling some shares to lock in profits may be wise. Otherwise, you may regret it when the music stops.

Is it worth investing $1,000 in Palantir Technologies now?

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Justin Pope has no position in any of the companies mentioned. The Motley Fool has positions in and recommends Palantir Technologies. The Motley Fool has a disclosure policy.