Throughout history, artificial intelligence (AI) has disrupted various technological advancements. An essential component of the AI fabric is semiconductors, with high-performance GPUs playing a significant role in generative AI, machine learning, and quantum computing.
Two prominent companies at the core of the AI semiconductor landscape are Nvidia and Advanced Micro Devices (AMD). Both these giants have established dominance over smaller players, fueling tremendous demand for their chips.
Investors who missed the Nvidia rally may be keen on exploring lesser-known names like Arm Holdings (NASDAQ: ARM), which went public recently but has remained overshadowed by other opportunities in the semiconductor space.
However, Arm Holdings made a massive splash during its earnings call for the fiscal third quarter, ended Dec. 31, prompting a nearly doubled stock price over the following three trading days.
Arm Holdings just smashed expectations
It’s important to recognize that the semiconductor industry operates in a cyclical manner, subject to fluctuations in chip demand and various external challenges. Arm Holdings has experienced inconsistent financial and operational performances over the past few years, a common trend in this industry.
However, the current semiconductor market is thriving, and Arm is reaping the benefits. For the quarter ended Dec. 31, the company reported a staggering 14% year-over-year increase in revenue to $824 million, significantly surpassing Wall Street’s consensus estimate of $761 million.
Furthermore, Arm delivered strong bottom-line performance, with adjusted earnings per share (EPS) of $0.29, narrowly beating its earlier guidance and analyst estimates of $0.25 per share. However, what truly sparked the stock’s meteoric rise was the management’s guidance for the current quarter, expected to generate between $850 million and $900 million in sales, well above analysts’ predictions.
Arm Holdings not only benefits from the current secular tailwinds in the semiconductor market but is also experiencing an unprecedented surge in stock purchases.
Image source: Getty Images.
Valuation is a concern
As of the time of this writing, Arm’s market cap has more than doubled since its earnings release. With a trailing-12-month revenue of $2.9 billion, the company is trading at a price-to-sales (P/S) multiple of about 40, comparable to Nvidia, a much larger and faster-growing business with more significant market share in AI chips.
Although Arm’s management deserves credit for its remarkable performance, the disconnect between the stock price and the company’s valuation relative to underlying results and peers is apparent.
Is Arm stock a buy now?
Arm Holdings may not be a poor investment choice, but its current valuation seems to be driven by momentum. Short-term traders may have purchased the stock in the hope of quick profits as AI stocks continue to surge, bearing significant risk.
If considering adding semiconductor stocks to a portfolio, Arm could be a reasonable option beyond mainstream opportunities. Nonetheless, purchasing the stock at an inflated price currently presents substantial downside potential.
The prudent move might be to monitor the company’s performance and management’s execution. A premium valuation could be justified if Arm continues to exceed its guidance and outperform analyst expectations. However, at present, the stock appears overvalued, possibly venturing into meme territory, with safer alternatives available for exposure to AI and semiconductor stocks.
Should you invest $1,000 in Arm Holdings right now?
Before buying Arm Holdings stock, one should consider the insights from the Motley Fool Stock Advisor analyst team, which identified what they believe are the 10 best stocks for investors to buy now, with Arm Holdings not making the cut. The 10 recommended stocks are projected to yield considerable returns in the coming years, thus providing an alternative perspective.
The Motley Fool has positions in and recommends Advanced Micro Devices and Nvidia, and it is noted that the views and opinions expressed herein are those of the author and not necessarily reflective of Nasdaq, Inc.
*Stock Advisor returns as of February 12, 2024
