Arm Holdings(NASDAQ: ARM) stock has been in sizzling form on the stock market in 2024, rising nearly 90% as of this writing thanks to a string of solid results in recent quarters that have bested Wall Street's expectations, and the company's latest quarterly results have further boosted investors' confidence in this British company's growth prospects.
Arm released fiscal 2025 second-quarter results (for the three months ended Sept. 30) on Nov. 6, and the stock jumped following the report. Let's look at the reasons why Wall Street gave Arm's results a thumbs up before examining the company's prospects to check if it can sustain its impressive momentum in 2025 as well.
Arm Holdings delivered better-than-expected results, and it has a robust revenue pipeline
Arm delivered fiscal Q2 revenue of $844 million, a jump of 5% from the same quarter last year. The reading was well ahead of the company's guidance range of $780 million to $830 million and also beat the FactSet consensus estimate of $810 million by a handsome margin. Arm's non-GAAP (adjusted) earnings of $0.30 per share also exceeded the guidance range of $0.23 to $0.27 per share. Wall Street would have settled for $0.26 per share in earnings from Arm.
However, it is worth noting that Arm's bottom line fell from the year-ago period's figure of $0.36 per share. The decline can be attributed to a 25% year-over-year increase in the company's non-GAAP operating expenses last quarter, which was driven by a 21% jump in its engineering headcount. At the same time, Arm's licensing revenue dropped 15% from the year-ago period to $330 million on account of "normal fluctuation in timing and size of multiple high-value license agreements and contributions from backlog."
Arm CFO Jason Child points out that the company's licensing revenue varies from quarter to quarter, which is why it would be prudent to take a closer look at the annualized contract value (ACV) of its licenses, which refers to "the total annualized committed fees, excluding any potential future royalty revenue, for all signed agreements" on the last day of the quarter. This metric increased by 13% year over year in the previous quarter to $1.25 billion, indicating that Arm is building a solid revenue pipeline.
Another metric that points toward a brighter future for Arm is its remaining performance obligation (RPO), which refers to the total value of the company's unfulfilled contracts. This metric jumped 10% year over year in the previous quarter to $2.38 billion. So, Arm's ACV and RPO increased at a faster pace than the growth in its top line last quarter, pointing toward stronger revenue growth in the long run.
However, there is one segment in which Arm is enjoying outstanding growth -- the royalty business. Apart from collecting a licensing fee from customers who use its intellectual property (IP) for designing chips, Arm also gets royalties from the shipment of each device containing chips that are designed using its IP.
The company's revenue from this segment increased an impressive 23% year over year last quarter to $514 million. This robust growth was driven by an increase in the number of chips manufactured using the company's latest Armv9 architecture, which now accounts for 25% of its royalty revenue as compared to 10% in the same quarter last year.
The adoption of Armv9 is growing thanks to the increasing demand for chips capable of powering artificial intelligence (AI) workloads in data centers, smartphones, and personal computers. From smartphone makers such as Apple to graphics processing unit (GPU) manufacturers such as Nvidia to cloud service providers such as Microsoft and Alphabet's Google, Armv9 has already built a solid customer base.
More importantly, Arm reportedly commands a much higher royalty rate as compared to the previous generation of Armv8 architecture. That's the reason why the company witnessed a 40% year-over-year jump in its smartphone royalty revenue last quarter, even though shipments increased only in the mid-single digits.
The good part is that the demand for Arm's licenses is increasing thanks to AI. The company had 39 licensees for its Arm Total Access license last quarter, up from 22 in the same quarter last year. Arm points out that the "target markets for these licensees include smartphones, AI accelerators, automotive applications, data centers, and embedded computing." So, an increase in the number of licenses should lead to robust growth in the company's royalty revenue as well in the long run.
Stronger growth is in the cards, but there is one concern
Arm is expecting its fiscal 2025 revenue to land between $3.8 billion and $4.1 billion. That would translate into 22% growth at the midpoint from fiscal 2024 levels. As the following chart indicates, analysts expect its robust growth to continue over the next couple of fiscal years as well.
ARM Revenue Estimates for Current Fiscal Year data by YCharts
Meanwhile, the company's earnings are forecast to increase at an annual rate of 31% for the next five years. All this tells us that Arm could keep growing at a healthy rate in the long run, but the stock's red-hot rally this year means that investors will have to pay a rich 236 times earnings to buy it. Moreover, Arm's forward earnings multiple of 97 is also on the expensive side, even though it points toward a healthy jump in the company's bottom line.
The price-to-sales ratio of 43 is also quite expensive. So, from a valuation point of view, buying Arm Holdings right now doesn't look like a smart move, considering that investors can get their hands on faster-growing AI stocks at a cheaper valuation.
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