On February 7th, $ARM Holdings Ltd(ARM)$ released its quarterly report, and its performance far exceeded expectations. Its stock price has continued to soar, surging over 151% from its IPO price, stunning the world:
Arm's explosive growth has successfully attracted the attention of investors, and with the king of AI, $NVIDIA Corp(NVDA)$ , heavily invested, the whole market is chomping at the bit for Arm.
But after the surge, Arm is too expensive!
Looking at its price-to-sales ratio, Arm is already one of the most expensive stocks in the $S&P 500(.SPX)$ , even topping Nvidia:
But compared to Nvidia, Arm's growth potential isn't that high. When it IPO'd in September last year, there were rumors that management expected revenue growth of around 15% per year for the next three years, with a long-term operating profit margin expected to reach 60%.
Currently, Arm management predicts revenue of approximately $3.385 billion in fiscal year 2024, analysts expect fiscal year 2025 to reach $3.937 billion. Assuming continued growth of 17% in fiscal year 2026, annual revenue of $4.6 billion. Calculating based on management's optimistic operating profit margin of 60%, its forward P/E ratio is a whopping 48 times!
This is all calculated under the most optimistic scenario. If it falls slightly short of expectations, the consequences are imaginable. Even though Arm holds a monopolistic position in the chip architecture industry and its future profitability is terrifying, a forward P/E ratio of 48 times is just too expensive!
At present, SoftBank holds 90% of Arm's equity, which will be unlocked this March. With such a surge, will SoftBank sell its shares?
Let's talk about Arm's fundamentals after discussing its valuation.
Arm is a chip design architecture company, mainly producing Arm architecture processors. Chip design companies like $Apple(AAPL)$, Nvidia, and $Qualcomm(QCOM)$ can design chips by purchasing Arm architecture.
In the industry chain, Arm architecture is similar to the foundation. Without it, chip design would be impossible, let alone manufacturing mobile phones and other electronic devices.
Take mobile phones as an example. Whether it's Apple, $Samsung Electronics Co., Ltd.(SSNLF)$ , or $XIAOMI-W(01810)$ $Xiaomi Corp.(XIACY)$, OPPO, and vivo, they all use Arm architecture:
Besides Arm architecture, there are two other mainstream architectures in the world: X86 and RISC-V.
X86 architecture is mainly held by $Intel(INTC)$ and $Advanced Micro Devices(AMD)$ . It has high performance but also high energy consumption, mainly used for PCs and servers.
Arm is mainly used for mobile devices and is adopted by 99% of the world's mobile phones. It is also starting to expand into IOT, PC, and server fields, with enormous potential. RISC-V has lower performance and is mainly used for light terminals like IOT devices:
Before 2016, Arm architecture was mainly used on mobile phones. Nowadays, it's used in mobile phones, consumer electronics, cloud computing, and even autonomous driving:
Even in the PC market dominated by X86, Arm is expected to nibble away at some market share. For example, last October, Qualcomm launched the PC chip "Snapdragon X Elite" based on the Arm architecture, and products equipped with this chip are expected to hit the market this year.
Nvidia and AMD are also developing PC chips based on the Arm architecture, which are expected to be released as early as 2025.
According to market research firm Counterpoint, in the global PC shipment market in 2022, Intel and AMD accounted for 70% and 17.6% of the market share, respectively, while Arm held 12.8%. It is expected that by 2027, Arm's share will exceed 25%.
In addition to PCs, Nvidia's GH200 Grace Hopper chip also uses the Arm architecture, indicating that AI is expected to drive a new wave of growth for Arm:
The application of Arm architecture is widespread, and the market size of various terminals is also expanding continuously. Arm can be said to be a golden child:
In addition to being in a golden industry, Arm's business model is also incredibly strong. Even though its architecture has been upgraded to V9, its older products are still earning long-term revenue for Arm:
From the perspective of Arm's revenue over the years, there is a strong certainty:
At the same time, thanks to its light asset characteristics, Arm's profitability is super high, with a gross margin of up to 95.6%:
But because Arm spends most of its revenue on research and development, its net profit margin is relatively low. So, if we calculate the PE ratio based on the net profit of the past four quarters, Arm's PE ratio is over 1000 times!
From the perspective of gross profit margin and expense ratio, if Arm cuts back on its investment, its profit margin is expected to reach a staggering 60%!
Arm is a rare great company. Otherwise, Nvidia would have wanted to acquire it for $40 billion in 2020. Unfortunately, the valuation of Arm is too high now!
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