Arm Holdings (ARM) was listed on the Nasdaq exchange a little over a year ago and has risen 125% since making its market debut. The company appears likely to benefit from the launch of Apple’s iPhone 16, which utilizes Arm’s most advanced microchips and processors. Despite this, I’m neutral on ARM stock as future earnings growth appears to be baked into the current share price.
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Arm’s Unique Technology
Before diving into my neutral view of Arm Holdings, let me explain a little bit about the company. Arm is a British semiconductor company headquartered in Cambridge, England. It’s listed in the U.S., but majority owned by Japanese holding company SoftBank (SFTBY). Arm specializes in developing and licensing high-performance, energy-efficient intellectual property (IP) for processors, notably central processing units, known as CPUs. The company operates a unique business model that involves licensing its designs to semiconductor manufacturers, allowing them to create customized chips.
This approach enables Arm to focus on innovation while enabling partners to leverage its technology across various applications. The company’s technology is foundational in many devices, powering over 99% of smartphones and a significant portion of other electronic devices. Arm Holdings has a 40% market share in the automotive sector, 26% in the networking equipment sector, and 65% in the Internet of Things (IoT) and embedded chip market.
The Apple Ecosystem
I remain neutral on ARM stock even though I acknowledge that the company is likely to benefit greatly from the new iPhone 16 that was launched earlier in September. Arm Holdings has an established relationship with Apple, and the iPhone maker has utilized Arm’s semiconductors in past iterations of its smartphone. In fact, Arm designed some of the earliest microchips found in Apple’s Mac computers back in the 1980s. Arm is very much embedded within the Apple ecosystem.
When it comes to the new iPhone 16, Arm should benefit from the fact that the artificial intelligence (AI) features are reliant on its technology. Arm’s newest V9 architecture that’s found in the iPhone 16 carries nearly double the royalty rate, which means that Arm stands to earn substantially more money per iPhone 16 sold. Higher royalties should translate to higher revenues for Arm. Estimates peg the royalty rate for the V9 licensing at 4.5% compared to the current rate of 1.7%. Improved royalty rates and revenues should position Arm Holdings to exceed its full-year royalty revenue growth forecast of about 20%.
Arm’s AI Tailwinds and Valuation
Another reason for my neutral view of ARM stock is its valuation. To be sure, the company is well-positioned to ride AI tailwinds. The company’s energy-efficient architecture is giving the company a competitive edge in the rapidly expanding AI infrastructure sector. Arm has also registered significant growth in the data center space as more companies develop custom chips for AI workloads. This trend is driving an increase in high-value licensing agreements. Arm recently reported that its Annualized Contract Value (ACV) grew by 14% year-over-year to $1.193 billion.
Despite these positives, Arm’s stock is trading at an extremely expensive valuation right now. The company’s future growth potential appears to be fully priced into the stock. Arm’s shares currently trade at 88.5 times forward earnings estimates, reflecting a 271% premium to the information technology (IT) sector. Even when accounting for growth — which is forecast at 26% annually — the stock looks expensive. The price-to-earnings-to-growth (PEG) ratio currently sits at 2.93 times, representing a 58.6% premium to the IT sector.
Is Arm Stock a Buy According to Analysts?
ARM has a consensus Moderate Buy rating based on the views of 20 Wall Street analysts. This is based on 14 Buy, five Hold, and one Sell rating assigned by analysts in the past three months. The average Arm stock price target of $137.43 implies 2.29% downside potential from current levels.
Read more analyst ratings on ARM stock
Conclusion:
Arm Holdings has several tailwinds working in its favor, including the launch of more sophisticated smartphones that use its chips and processors. However, the stock is expensive and future earnings growth appears to be priced into the share price. While Arm appears to be a great company, its stock carries a sizeable price tag. As such, I am neutral on this security.
