Arm Holdings (ARM) recently beat first-quarter earnings expectations by some distance but slumped as the firm elected not to raise guidance for the full year. While Wall Street came to the semiconductor company’s defense, the stock continues to trade at very high multiples despite the selloff. Considering these factors, and given the company’s strong long-term prospects, it appears that the stock is trading above fair value, suggesting potential overvaluation at current levels. Therefore, I’m maintaining a neutral stance.
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Arm Holdings’ Strong Q1
To understand the current dynamics of Arm Holdings, it’s essential to first examine their recent quarterly performance. Arm Holdings is a British semiconductor and software design company. Founded over 30 years ago, it is known for its energy-efficient processor architectures and now plays a crucial role in powering a vast array of devices, from smartphones to data centers. The jewel of the British technology sector was acquired by SoftBank Group (SFTBY) in 2016, before a partial listing on NASDAQ last year.
Following its listing, the stock experienced a significant surge. However, recent developments have led to a reversal, despite the company’s impressive first-quarter results. For the quarter ending June 30, 2024, Arm reported adjusted earnings of $0.40 per share, which comfortably surpassed the consensus estimate of $0.35 per share. This strong performance was further highlighted by a 39% year-over-year increase in revenue, reaching $939 million and exceeding the expected $906.5 million.
The revenue growth was driven by a remarkable 72% rise in license revenue to $472 million and a 17% increase in royalty revenue to $467 million. These figures reflect Arm’s robust market position and its successful execution of key strategies. However, the positive financial results were overshadowed by subsequent market reactions.
However, despite these strong numbers, the stock took a nosedive. The initial euphoria was short-lived as the stock slumped sharply in after-hours trading. This downturn, while surprising given the solid Q1 results, can be attributed to the company’s cautious guidance for the rest of the year. At the time of writing, ARM stock is down 41.4% over the past month.
Arm’s Guidance Disappoints
Transitioning from strong quarterly results to the full-year outlook, Arm’s guidance for the upcoming period has disappointed investors. The company projected adjusted earnings of $0.23 to $0.27 per share on revenue of $780 million to $830 million. These figures are notably lower than the Q1 results and fall short of analysts’ expectations of $0.26 per share on $812.75 million in revenue.
This cautious outlook reflects Arm’s strategic pivot towards higher-value markets, such as data center servers and AI accelerators. While these sectors are less dependent on high volume, like smartphones, they offer higher margins.
Moreover, analysts have noted that although Arm’s designs are crucial for AI applications, the company has not yet capitalized on the AI boom to the same extent as competitors like Nvidia (NVDA). Arm’s CFO, Jason Child, highlighted the increasing investment in AI, suggesting potential for future growth.
Looking ahead, Arm maintained its full-year guidance, expecting sales between $3.8 billion and $4.1 billion and adjusted earnings between $1.45 and $1.65 per share. This guidance aligns closely with some analysts’ expectations but falls short of others. Many analysts had anticipated that Arm would raise its outlook given the strong Q1 results.
Wall Street Comes to Arm’s Rescue
In the face of disappointing guidance, Wall Street analysts have rallied to defend the British chip designer. They continue to highlight the company’s strong fundamentals and strategic positioning in key growth areas. Bank of America (BAC) analyst Vivek Arya stated that while cyclical headwinds in the Internet of Things, networking, and industrial segments kept the FY2025 forecast largely unchanged, Arm’s exposure to significant semiconductor megatrends makes it a compelling investment. Arya reiterated a Buy rating and a $180 price target—one of the most bullish among analysts—and emphasized Arm’s role in driving increasing royalty rates and the spread of AI from core to edge.
Meanwhile, Morgan Stanley (MS) analyst Lee Simpson also defended Arm, pointing to robust licensing results that indicate growing interest in Arm’s products. Simpson highlighted long-term deals, including a significant agreement with Apple (AAPL), and noted the momentum in Arm’s v9 architecture—a new technology with strong margins—that now accounts for 25% of royalties. Simpson, another Arm bull, maintained an Overweight rating with a $190 price target.
Additionally, Andrew Gardiner, an analyst at Citi Group (C), raised his price target to $170 from $140, acknowledging near-term royalty weaknesses but emphasizing long-term licensing strength. Similarly, Barclays analyst Tom O’Malley increased his price target to $125 from $105 while maintaining an Overweight rating.
Does Arm’s Valuation Make Sense?
With these mixed signals in mind, assessing Arm Holdings’ stock valuation becomes key. Investing in growth stocks often involves betting on future gains, but it can also leave room for short-term earnings hiccups. Arm Holdings is a big player in several key sectors, which boosts its future growth potential. However, the stock is currently trading at a hefty multiple of 70.75 times its forward earnings. This high valuation reflects strong investor confidence in Arm’s growth, but it also means the stock is priced with big expectations.
So, while Arm’s solid position in important markets supports its growth story, the sky-high valuation raises questions about whether the current price justifies the high expectations. It’s essential to consider whether these expectations are realistic or if there’s a risk of short-term earnings challenges.
Is Arm Stock a Buy, According To Analysts?
On TipRanks, ARM is rated as a Moderate Buy based on 14 Buy ratings, four Hold ratings, and one Sell rating assigned by analysts over the past three months. The average ARM stock price target is $139.31, implying a 17.6% upside potential.
The Bottom Line On Arm Stock
Arm Holdings posted strong first-quarter results, but the stock has fallen due to disappointing full-year guidance, suggesting it might be overvalued. Despite beating earnings expectations and showing impressive revenue growth, the stock’s high valuation of 70.75 times its forward earnings means it’s priced with high expectations. While analysts are optimistic about Arm’s future in key areas like AI, the current price may not reflect its true value. Therefore, I’m maintaining a neutral stance on Arm Holdings.
