Up 66% YTD, Is Arm Holdings Stock Overvalued?

Over the past few years, demand for artificial intelligence (AI) chips has surged massively, fueled by widespread AI adoption and robust growth projections for the AI market. Shares of Arm Holdings Plc ADR (ARM), a leading processor-architecture solutions provider company controlled by SoftBank (SFTBY), have been major beneficiaries of the heightened investor excitement surrounding AI.

Arm Holding shares have gained more than 95% since their stock market debut on Sep. 14, 2023. At $51.00 per share, Arm Holding raised $4.87 billion, valuing the company at $54.5 billion—the largest IPO since late 2021. 

In its first trading day, Arm Holdings stock rose 25%, closing at $63.59 per share and reaching a $65 billion valuation. However, the stock witnessed its most noteworthy single-day spike of nearly 47% following an AI-powered Q3 earnings beat and an annual guidance raise in February.

Arm stock has returned 66.2% YTD, but this massive rally has ignited worries about its overvaluation. 

About Arm Holdings Stock

UK-based Arm Holdings Plc ADR (ARM) is a leading semiconductor and software design company specializing in the development and licensing of intellectual property (IP) for central processing unit (CPU) products and related technologies. ARM's technology is the foundation of multiple electronic devices, from smartphones to sensors, and is increasingly important in the Internet of Things (IoT) and AI industries. Its market cap currently stands at $127.7 billion.

Over the past six months, ARM has rallied 142.58%, substantially outperforming the S&P 500 Index’s ($SPX) 23% rise.

Arm Holdings stock trades at 104x forward earnings, significantly higher than its closest peers. Even though analysts expect EPS growth of 41.5% over the next 3-5 years, this valuation is expensive, as evident from the 2.49x price/earnings-to-growth (PEG) ratio, which is 31% higher than the industry average of 1.9x.  

The stock also looks expensive in terms of price/sales, which stands significantly higher than its industry peers at 43.49x.

Arm's Strong Q3 Performance Beat Wall Street Projections

Shares of Arm surged after its impressive earnings report on Feb. 7. Its fiscal Q3 total revenue increased 14% year over year to $824 million, surpassing Wall Street projections. Its adjusted EPS of $0.29 also beat analysts' expectations by 16%.

Arm’s licensing revenue, which grew 18% year over year to $354 million, was supported by increasing demand for new technology driven by all things AI. CEO Rene Haas said, "The AI wave drove licensing growth as these new devices require Arm's performant and power-efficient compute platform." Moreover, Arm is financially healthy, with $1.6 billion of cash on hand and no debt.

In February, GPU chip market leader Nvidia (NVDA) announced a $147 million investment in Arm Holdings, giving the stock an additional boost.

Arm Holdings' long-term growth hinges on increasing demand for computing driven by complex electronic devices, gaining market share in automotive and cloud servers, and advancements in AI technology requiring high-performance and energy-efficient processors. Additionally, Arm's Compute Subsystems and the ecosystem of software and design partners should contribute to its growth trajectory.

Looking ahead to the fourth quarter of 2024, ARM projects EPS between $0.28 and $0.32, with revenue between $850 million and $900 million. ARM also raised its fiscal year 2024 revenue forecast to $3.16-$3.21 billion, with adjusted EPS projected between $1.20 and $1.24.

Analysts tracking Arm Holdings expect adjusted earnings per share to be $1.21 in 2024 and $1.52 in 2025.

What Do Analysts Expect for Arm Holdings Stock?

Arm Holdings stock has a consensus “Moderate Buy” rating. Of the 23 analysts offering recommendations for the stock, 13 rate it a “Strong Buy,” nine suggest a “Hold," and one advises a “Strong Sell.”

Morgan Stanley's Lee Simpson recently reiterated  a “Hold” rating on the stock, with a $107 price target, nearly 15% below the stock’s current price. The average analyst price target for Arm Holdings is even lower, at $92.53. 

However, the Street-high price target for ARM is $180, as assigned by Rosenblatt in February, suggesting that the stock could rally as much as 44.8% from current levels. Rosenblatt analyst Hans Mosesmann believes ARM is well-positioned to benefit from improving royalty trends, and sees its AI tech becoming “indispensable.”