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Enthusiasm about artificial intelligence (AI) has pushed the S&P 500 (SNPINDEX: ^GSPC) to dozens of record highs in 2024. Palantir Technologies (NYSE: PLTR) and Arm Holdings (NASDAQ: ARM) have benefited greatly from that momentum, notching year-to-date gains of 61% and 145%, respectively.

However, some Wall Street analysts think the stocks have gotten ahead of themselves. Their 12-month price targets imply substantial downside for shareholders.

• Rishi Jaluria at RBC Capital Markets has set Palantir with a price target of $9 per share, which implies 67% downside from its current share price of $27.
• Javier Correonero at Morningstar has set Arm with a price target of $66 per share, which implies 64% downside from its current share price of $182.

Should investors sell these high-flying AI stocks?

Palantir Technologies: 67% implied downside

Palantir provides four primary software platforms. Gotham and Foundry let clients integrate data, develop artificial intelligence (AI) and machine learning (ML) models, and design analytics applications to improve decision-making. Apollo is a delivery system that updates both platforms, and AIP (Artificial Intelligence Platform) brings support for generative AI to Gotham and Foundry.

Analysts have mixed opinions about Palantir. In the bull camp, Forrester Research ranks the company as a leader among AI/ML platform providers, and Dresner Advisory Services ranks it as a leader in ModelOps, which deals with developing, deploying, and optimizing AI/ML models. Last year, Dan Ives at Wedbush Securities said Palantir was "probably the best pure play AI name."

In the bear camp, Gartner ranks Palantir below most peers in data integration tools, and the consultancy did not even mention Palantir in a recent report on data science and ML platforms. Last year, Rishi Jaluria at RBC Capital said conversations with industry experts and company employees suggest Palantir "does not appear to be anything truly differentiated when it comes to generative AI."

Palantir reported decent financial results in the first quarter. Revenue increased 21% to $634 million and non-GAAP earnings increased 60% to $0.08 per diluted share. Management noted "unprecedented demand driven by momentum from AIP." Yet, the company guided for full-year revenue growth of 20%, implying a slight deceleration in the coming quarters.

Wall Street expects adjusted earnings per share to grow at 22% annually through 2026. That estimate makes the current valuation of 99 times adjusted earnings look very expensive. I doubt Palantir shares will plunge to $9 as Rishi Jaluria expects, but investors should consider trimming their position here.

Arm Holdings: 64% implied downside

Arm designs central processing unit (CPU) architectures that it licenses to clients like Apple, Amazon, and Nvidia. Those companies use Arm-based products to develop their own chips and systems. They have the option of building chips with custom cores (the processing engines in CPUs), or purchasing off-the-shelf cores from Arm. The latter option outsources an even larger portion of chip-related R&D expenses.

Apple's M-series chips are an example of Arm-based CPUs with custom cores. But Amazon's Graviton processors and Nvidia's Grace CPUs feature off-the-shelf Arm Neoverse cores, which are optimized for cloud computing and artificial intelligence. By comparison, Cortex-series cores from Arm are optimized for mobile and IoT devices.

Every CPU has an instruction set architecture that defines how the hardware interacts with software. Arm architectures are known for their low power consumption, and Arm-based chips are virtually ubiquitous in devices where power efficiency is critical. For instance, its technology is present in 99% of smartphones, and it holds 60% market share in other mobile devices.

Meanwhile, x86 archtectures used by Intel and Advanced Micro Devices have traditionally been associated with superior computational performance. That edge has allowed those chipmakers to dominate the personal computer (PC) and data center markets.

Companies on both sides have tried to expand their influence, but Arm has been more successful. Intel and AMD have made little progress in mobile devices, but Arm gained three points of data center market share between 2020 and 2023, according to CFRA analysts. Additionally, CEO Rene Haas recently predicted Arm would hold 50% PC market share by 2029, up from 17% in 2024.

Arm looked strong in the fourth quarter of fiscal 2024 (ended March 31). Revenue increased 47% to $928 million and non-GAAP net income improved to $0.36 per diluted share, up from $0.02 per diluted share last year. But management gave guidance implying 22% revenue growth in fiscal 2025, a surprising deceleration given the theoretically high demand for AI chips.

Of course, that outlook could be nothing more than caution on behalf of management, but there is another problem investors should consider. Wall Street expects Arm to grow adjusted earnings per share at 27% annually through fiscal 2026. That forecast makes its current valuation of 144 times adjusted earnings look outrageously expensive. Personally, I doubt Arm shares will fall 64%, but investors should consider trimming their positions here.

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John Mackey, former CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Trevor Jennewine has positions in Amazon, Nvidia, and Palantir Technologies. The Motley Fool has positions in and recommends Advanced Micro Devices, Amazon, Apple, Nvidia, and Palantir Technologies. The Motley Fool recommends Gartner and Intel and recommends the following options: long January 2025 $45 calls on Intel and short August 2024 $35 calls on Intel. The Motley Fool has a disclosure policy.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.