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.
Arm Holdings Beats Estimates
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.
The stock has surged since its listing but recently reversed after its first-quarter report, despite reporting strong Q1 numbers. For the quarter ending June 30, 2024, Arm reported adjusted earnings of $0.40 per share, surpassing the consensus estimate of $0.35 per share.
Moreover, revenue surged by 39% year-over-year to $939 million, beating the expected $906.5 million. This growth was driven by a 72% increase in license revenue to $472 million and a 17% rise in royalty revenue to $467 million.
Unfortunately, Arm stock slumped in after-hours trading and has continued its downward trend. This was due to the disappointing guidance provided. At the time of writing, ARM stock is down 41.4% over the past month. That’s a mammoth selloff, albeit one that was in part induced by the broader selloff in technology stocks.
Arm’s Guidance Disappoints
However, despite the strong Q1 results, 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 To Arm’s Rescue
Wall Street analysts have rallied to defend the British chip designer and collectively remain quite bullish on the stock. Despite the disappointing guidance, analysts have highlighted 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.
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?
Investing in growth stocks is all about looking ahead and betting on future gains. This usually means focusing on long-term growth and future cash flows, 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.
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
So, while Arm’s solid position in important markets backs its growth story, the sky-high valuation suggests that investors are banking on a lot of future success. It’s worth considering whether those high expectations are justified or if there’s a risk of short-term earnings challenges.
