The high valuation of Arm Holdings’ stock presents a risk of a post-earnings sell-off this week. Arm, identified under the ticker symbol ARM, has been gaining significant attention in the semiconductor industry. Its technology is integral to half of all chips and nearly all smartphones, including Apple’s iPhone 16. Since its initial public offering last year, the company’s shares have increased by 141%.
Arm operates on a business model centered around licensing and royalty revenue, making it robust. Despite potential investor interest in purchasing shares, the stock’s high valuation raises concerns. With the upcoming quarterly earnings report on November 6, any earnings miss could lead to a decline in stock value, prompting investors to reconsider buying before the release of its fiscal year’s second-quarter report for 2025.
Arm has demonstrated strong business performance, with fiscal first-quarter revenue rising by 39% year over year, thanks to unprecedented licensing revenue. Notably, companies like Alphabet’s Google and Amazon Web Services have engaged with Arm-based chips in their data centers.
The company benefits from a model that does not necessitate substantial capital investment in manufacturing equipment and facilities. Arm focuses on chip design and licenses its technology, drawing royalty revenue from each chip shipped. Examples include Nvidia’s Grace CPUs, which utilize Arm technology. This framework contributes to Arm’s high-profit margins.
The business model is powerful with promising growth prospects, experiencing increased adoption of its Armv9 chip design in various sectors including data centers, cloud servers, and the automotive industry. In the previous quarter, licensing revenue saw a 72% surge compared to the same period last year. Although such revenue can fluctuate between quarters, it suggests long-term growth in royalties. Arm indicates that the timeline from signing a licensing deal to realizing royalties from new products can extend over four years.
With the widening use of Arm-based chips for artificial intelligence workloads in data centers and AI-enabled devices, the company anticipates several years of solid revenue and earnings growth.
However, the primary concern is the high valuation of Arm’s stock. The forward price-to-earnings (P/E) ratio stands at 98, with analysts forecasting a 22% earnings increase for the fiscal year ending in March, followed by a 32% boost the subsequent year, according to Yahoo! Finance. Additionally, analysts project a 31% decline in fiscal Q2 earnings year over year to $0.25, while revenue is expected to rise by only 8% compared to the previous year. Although this variation is typical for Arm’s business, it suggests potential risk in sustaining growth to support the high valuation, potentially resulting in a stock downturn post-earnings report.
Investors are advised to wait for more growth before investing at such a high forward P/E multiple, considering the availability of other leading semiconductor firms that also benefit from AI demand but offer a more appealing growth-to-value ratio. Investors should keep Arm’s shares under observation and contemplate purchasing during a market pullback.
