This Stock Costs an ARM and a Leg

Initial Public Offerings (IPOs) have been few and far between this year.

Maybe that’s because they were making space for Arm Holdings’ (ARM) debut, the largest public offering since 2021, coming in at a $65 billion market cap.

The semiconductor behemoth caught the attention of many financial pros as search volume soared.

Yet, over a month later, that search volume hasn’t waned.

However, it’s not all positive attention.

Many financial pros are looking at articles questioning Arm’s valuation and future growth, rightfully so.

The company costs a pretty penny, and there’s no guarantee it will meet investors’ expectations.

But let us lay out the case so you can make up your mind about the newest semiconductor stock.

Arm Holding’s Business

ARM Holdings isn’t just another semiconductor company; it’s a market disruptor with a highly successful IPO under its belt, with an offering that was oversubscribed by ten fold.

You may recall NVIDIA (NVDA) attempted to buy ARM in 2020 for $40 billion, only to be foiled by global regulators.

The company carved out a niche with its energy-efficient CPU architectures.

Where other CPUs guzzle energy, ARM’s are sipping it—crucial in an age when battery life is king. This made them the bedrock for over 250 billion chips shipped to date.

ARM segments its business into the following areas:

• Licensing (37% of total revenues) – ARM’s bread and butter; the company licenses its CPU designs to a gamut of manufacturers.
• Royalties (63% of total revenues) – This is where ARM really shines, collecting a continual stream of royalties from sold chips incorporating its technology, a high-margin game with little to no incremental costs.

But it’s not all champagne and roses. Despite strong financial performance—think high gross margins and cash generation—investors should exercise caution.

ARM’s current valuation pitches it at around 77x operating income and over 19x sales. Even by tech industry standards, that’s frothy.

But let’s not bury the lead—investors find plenty to love about ARM. 

We’re talking about a company that dominates the CPU architecture space, especially in the mobile sector. 

This isn’t some flash-in-the-pan tech startup; ARM’s been around, and it shows in their entrenched partnerships with titans like Apple and Google. 

Financials

Source: Stock Analysis

We can’t overlook the cash-generation prowess. 

With minimal capital expenditure and capex hovering around 2-3% of revenue, ARM is a cash cow, enabling a strong balance sheet with minimal debt and robust R&D investment. 

In an industry where innovation is the currency, ARM’s financials and market position give it a distinct edge.

Valuation

Source: Seeking Alpha

The P/E ratios going back a few years add texture to ARM’s current valuation.

Those, along with the price-to-sales and price-to-cash ratios show ARM price not much worse, and in some cases better, than high-flyer NVDA.

Other low-growth players like Qualcomm (QCOM) and ON Semiconductor (ON) trade at far more reasonable valuations.

Growth

Source: Seeking Alpha

The revenue growth of each company rightly sums up the valuation disparity.

However, ARM’s $2.66 billion in revenues is down YoY, as noted above, and only 31.3% above 2021’s revenues.

NVDA saw growth slow this year. But its AVERAGE for the last three years is 35.8%.

Additionally, ARM China accounts for 24% of ARM’s revenue, putting future growth at risk.

Profitability

Source: Seeking Alpha

If ARM can hit the growth numbers baked into the stock, its margins would generate huge amounts of cash.

Of its peers, ARM boasts the highest levered free-cash-flow margin, more than 5% above industry-leading NVDA.

Our Opinion 4/10

ARM runs an incredible company that oozes cash…

…BUT…its stock price reflects exceptionally high revenue growth expectations.

With hinting at a global slowdown, we don’t believe ARM will do better than NVDA, which is already showing signs of weakness.

Additionally, its exposure to China’s economy and mobile market puts them at high risk of a sales slowdown.

At some point ARM may be a buy. But until we have better visibility into their revenue growth, it’s a pass for us.