• Palantir stock is falling because of budget cut proposals at the federal government.

• The business should grow just fine, even if budget cuts occur.

• The stock is still expensive after the recent sell-off.

After the U.S. presidential election, Palantir Technologies stock soared about 200%. But since hitting its all-time high on Feb. 19, the stock is down over 30%. The artificial intelligence (AI) company is growing quickly, but due to its reliance on government contracts, investors are worried that potential budget cuts at the Department of Defense and other government agencies could hurt the business. Despite the drawdown, Palantir is still valued at over $195 billion.

What's going on with Palantir stock? Is now a good time to buy the dip? Let's take a closer look at this software upstart and see how the stock could fit into your portfolio.

Budget cuts at the Pentagon

The Trump administration has come out swinging with its cost-cutting initiatives at the federal government. The focus has now shifted to the Department of Defense and its $850 billion annual budget, one of the government's largest outlays each year. New Secretary of Defense Pete Hegseth said he aims to cut 8% from the defense budget every year for the next five years. That is not a one-time cut of 8% but five consecutive years of cuts.

Hegseth is starting with civilian workers, aiming to cut over 5,000 people from the payroll. Investors took this as a negative sign for Palantir and other defense contractors, breaking what momentum the stock had after its Q4 earnings results. As of this writing, the stock has fallen in six of the last eight trading sessions.

While budget cuts may prove a headwind over the long term for defense contractors, I could also see an argument that they're bullish for Palantir. Why? Because efficiency gains are what Palantir is selling to the federal government. Its software and AI tools are supposed to enhance productivity, which could mean new contracts if they lead to overall cost savings.

In 2024, Palantir generated $1.57 billion in revenue from government contracts, making it only a small part of the federal budget. Despite the current administration's proposed cost cuts, I still expect this figure to grow in the coming years.

Palantir is more than government contracts

In recent years, government contracts have also become a shrinking share of Palantir's top line. A push into the commercial sector has been very successful with the company winning hundreds of customers for its AI and software tools.

U.S. commercial revenue grew 64% year over year in Q4 2024 to $214 million, and the commercial segment now makes up 45% of overall sales. While the government segment is still growing, the commercial side is growing even faster.

The commercial market is simply much larger and could provide a $10 billion-plus revenue opportunity for Palantir. Last quarter, its backlog for U.S. commercial contracts grew 99% year over year to $1.79 billion.

This trend should help Palantir diversify away from federal government contracts. If budget cuts at the Department of Defense do affect the company, it won't kill the entire business.

PLTR PS Ratio Chart

Is Palantir stock a buy?

Despite falling 32% in less than two weeks, Palantir stock is not necessarily a buy.

Before the sell-off, Palantir had a price-to-sales ratio (P/S) of more than 100. It sits at 73 as of this writing, and this big a premium comes with truly high expectations for future growth and earnings.

To illustrate, consider that Palantir generated $2.87 billion in revenue last year. If the company grows its revenue by 30% annually for the next five years, its top line will reach $10.65 billion. Apply a 30% profit margin -- which would be a significant expansion from current levels -- and you get $3.20 billion in annual earnings.

Based on Palantir's nearly $200 billion market cap as of this writing, that bullish five-year earnings estimate would still leave the stock with a price-to-earnings ratio (P/E) of 62. In other words, even if Palantir keeps up its current growth streak while nearly doubling its profitability, the stock still looks overpriced following its drawdown. Valuation matters, and investors would be wise to approach this stock with caution.