At 130x Forward Earnings, Is Arm Stock (NASDAQ:ARM) Priced for Perfection?
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At 130x Forward Earnings, Is Arm Stock (NASDAQ:ARM) Priced for Perfection?

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Arm Holdings is an exceptional business with great margins — some of the best in the world. However, it’s currently trading at 130x forward earnings, and it may just be priced for perfection.

Free ARM Analysis

Arm Holdings (NADSAQ:ARM) stock is up 52.7% year-to-date. In fact, the stock is up more than 100% since its listing on September 14, 2023, at $51 per share. It’s also the seventh most valuable company in the UK. However, at 130x forward GAAP earnings, I feel that Arm Holdings stock might be priced for perfection. So, while I’d love this British success story to succeed further, I’m neutral on the stock.

Arm Holdings Is a Brilliant Business

Arm is a great business, and this is reinforced by its extraordinarily strong margins. Arms Holdings’s highest quarterly gross margin in recent years was 96.04%, and it rarely drops below 90%. This reflects the company’s business model, whereby it doesn’t actually produce the chips itself but licenses out its architecture.

It’s also a market leader in efficient chip design, and that’s reflected in its growing market share across most core segments. With increasing floorspace designated to artificial intelligence (AI) accelerators, Arm will likely continue to build out its position in the mobile and laptop market. Moreover, Arm’s chip design appears to be a clear winner with data centers, with hyperscaler capex (capital expenditures) representing a major tailwind for the British company.

Arm currently plays a major role in mobile and laptop processors, but it also helps design a lot of chips for the data center market. Tech giants including Microsoft (NASDAQ:MSFT) and Amazon (NASDAQ:AMZN) create chips based on Arm solutions. These big companies develop Arm-based chips tailored to their specific CPU design requirements.

Arm Holdings’ AI Chips

Arm Holdings is set to develop its own AI chips, with a prototype expected by spring 2025. That’s according to Nikkei, which said the UK-based semiconductor designer was looking to increase its exposure to the booming AI segment. The report suggests that Arm Holdings will create its own AI chip division, which will later be spun off into its own company. The new entity would be owned by SoftBank (OTCPK:SFTBF), which holds a 90% stake in Arm.

While Arm has decided to produce its own AI chips through contract manufacturing, some suggest that continuing to license its AI chip architecture to other companies would align better with its traditional business model.

According to reports, however, initial development costs could reach hundreds of billions of yen, with contributions from SoftBank. Masayoshi Son has set aside JPY 10 trillion to turn SoftBank into an AI powerhouse, with some of that funding likely going towards the initiative.

Nikkei stated that Son had visited chip manufacturers in Taiwan and the U.S. to discuss available production capacity. SoftBank plans to build data centers equipped with its chips in the U.S., Asia, Europe, and the Middle East from 2026, alongside wind and solar farms to power them. Sadly for Brits like me, I doubt any of these will be in the UK.

So, what does this mean for Arm Holdings? Well, we know so little about it. It’s hard to say. However, if Arm’s funds are used to develop a new AI chip entity that is eventually spun off to be owned by SoftBank, it might not be beneficial for Arm shareholders. Of course, it wouldn’t be as straightforward as that, but it’s possible that shareholders in the UK firm could lose out depending on the way things play out. It could, however, be a win for shareholders depending on several factors. We just don’t know enough yet.

ARM Stock Is Priced for Perfection

Arm’s valuation is wild. It’s trading at 130x forward GAAP earnings and 72.3x forward non-GAAP earnings. It’s one of the most expensive stocks I’ve come across from a near-term perspective, and it’s very hard to justify such a valuation. Arm Holdings really does appear to be priced for perfection. Any earnings miss or a drop in guidance could result in a serious drop in the share price.

Of course, so many of us are bullish on the chip sector, data centers, and AI at the moment — myself included. As such, it seems unlikely that Arm Holdings will drop its guidance. But sentiment can change quickly. Currently, Arm Holdings has a price-to-earnings-to-growth (PEG) ratio of 2.4x (1.0x or lower is generally seen as undervalued).

Is Arm Holdings Stock a Buy, According to Analysts?

On TipRanks, ARM stock comes in as a Moderate Buy based on 12 Buys, five Holds, and one Sell rating assigned by analysts in the past three months. The average Arm Holdings stock price target is $117.60, implying 2.6% upside potential.

The Bottom Line on Arm Holdings

Arm Holdings is an excellent business with amazing margins. In fact, I can’t name another stock that comes close to those margins. However, with a forward price-to-earnings ratio of 130x (72.3x non-GAAP), I find it very challenging to get behind the stock. Its reported desire to enter the AI chip segment sounds interesting, but we need more information before we can truly understand what this means for the stock.


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