3 Overvalued Stocks Set for a Brutal Reality Check

The tech sector witnessed record highs on Tuesday, driven by continued interest in companies focused on artificial intelligence (AI). However, there are concerns about overvalued stocks as investors show exuberance around certain companies’ prospects.

Recent equity index gains appear to stem primarily from a small number of large firms. Even typically bullish analysts covering the tech industry believe enthusiasm has slightly surpassed rational expectations, suggesting a correction is on the line.

Analysts conclude that share prices of certain stocks from various sectors have exceeded earnings growth. Some shares have rocketed to unsustainable levels, warranting short-term declines. However, others face potential longer-term downside should fundamentals fail to justify high prices.

Investors tend to speculate on tech stocks that are not currently worthwhile but promising long-term. Several technology companies in 2024 have seen share prices rising faster than earnings.

The following three overvalued stocks could face a sobering reality should earnings fail to justify soaring share valuations.

Palantir Technologies (PLTR)

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The data analytics and AI firm Palantir Technologies (NYSE:PLTR) continues to drive innovation in its industry. Its revenue grew 21% over the last year, reaching solid earnings levels for a large firm. The company also recently became profitable, with EBITDA increasing 37%. Such results would satisfy most industrial companies.

However, Palantir’s share price has risen 68% over the same period, resulting in an overvalued price-to-earnings ratio (P/E) of 215.3x. This ratio far exceeds what most investors find reasonable. PLTR stock price jumped when the company expanded into AI over a year ago. Yet, Palantir’s earnings have not kept pace with the rising share price, leaving the company with triple-digit P/E ratios for almost a year.

Analysts are concerned about Palantir and believe it is one of the overvalued stocks set for a brutal reality check. Many recommend selling PLTR, with an average price target 16% below the current share price. Notably, PLTR stock recently reversed after reaching levels near its 52-week high.

ARM Holdings (ARM)

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The U.K.-based chip designer ARM Holdings (NASDAQ:ARM) has received significant attention since its initial public offering (IPO) last year. ARM stock price has risen almost 200% since last September, a noteworthy performance given that the company designs but does not manufacture chips.

While ARM benefits from the hype around AI, it only recently established its own chip division and plans to enter the market next year. Currently, it relies on licensing and royalty fees from expanded server demand to support AI growth, fueling 47% revenue growth over the past year. However, it expects revenue growth to slow to approximately 22% for the next year, with similar earnings growth.

Despite tempting financials, ARM’s share price has risen much faster than earnings, leading to a P/E ratio of 582.7x. This positions it among the highest of overvalued stocks globally. On average, analysts expect ARM stock to decline to around $125.62, representing a potential downside of over 25% from current levels.

CrowdStrike (CRWD)

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CrowdStrike (NASDAQ:CRWD), a cyber security company that protects cloud computing and servers, is the last pick on this list of overvalued stocks to consider letting go. It would naturally do well as AI drives demand for digital storage and decentralized processing.

The company saw its annual recurring revenue (ARR) grow by 33% over the last year. It delivered record cash flow generation and a 63% increase in its adjusted EPS to $0.93 per share. However, analysts have concluded that the fast 163% growth in CRWD stock prices over the last year has caused the stock to become overvalued, pushing its P/E ratio to 717x.

This overvaluation is one reason Piper Sandler’s analyst downgraded the company’s outlook. While CrowdStrike continues to see strong growth, it faces increased competition from Zscaler (NASDAQ:ZS) and Palo Alto (NASDAQ:PANW). There is also growing concern that market sentiment could turn at any moment and take the overvalued stock back to an industry-standard valuation of 48x.

On the date of publication, Stavros Tousios did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.

On the date of publication, the responsible editor did not have (either directly or indirectly) any positions in the securities mentioned in this article.