A couple of years ago, many American investors probably had never heard of British chip designer Arm (NASDAQ:ARM), which has become a Wall Street darling on the artificial intelligence hardware trend. Ignore the temptation to jump in now; it’s too late as ARM stock is grossly overvalued.
Don’t get the wrong message. Arm’s a bad company, by any means. Indeed, an array of technology companies use Arm’s chip designs. But then, the market already knows this and has already baked a lot of hope and hype into the Arm share price.
First, the Good News About Arm
If we completely ignore Arm’s valuation, it’s quite easy to build a bullish argument for investors. Impressively, Arm grew its sales by 47% year over year to $928 million in fiscal 2024’s fourth quarter.
As The Wall Street Journal pointed out, “growing demand for artificial intelligence chips” drove Arm’s massive sales growth. Analysts had only expected Arm to generate $880 million in quarterly revenue, so there’s no denying that this was a big win for the company.
Yet, Arm stock fell after the company released its quarterly financial report. Commentators with Yahoo! Finance seemed baffled by the share-price drop. Maybe you’re confused, as well.
Moreover, Arm ambitiously guided for current-quarter revenue of $875 million to $925 million. So, why didn’t stock traders go on a buying spree?
It’s All Priced In, and Then Some
The answer is that investors already went on a buying spree. ARM stock shot up like a rocket in February after the company released its third-quarter fiscal 2024 earnings report.
Then, the stock rallied sharply again in April, May and the first half June, probably because of the market’s general AI-hardware hype.
Remember, this stock traded at around $70 at the beginning of 2024. Recently, the Arm share price hit $160. That rally goes far above and beyond Arm’s aforementioned 47% YOY revenue growth.
Hence, it’s reasonable to conclude that Arm’s sales growth has already been priced into the shares, and then some. Therefore value-conscious investors need to be careful now.
To quantify my concerns, note that Arm’s GAAP-measured trailing 12-month price-to-earnings ratio is an eye-popping 600.45x.
Since we already discussed Arm’s sales growth, it’s worth mentioning that Arm’s trailing 12-month price-to-sales ratio is 55.35x. Just for reference, the sector median P/S ratio is around 3x.
ARM Stock: Be Ready for Sub-$100
Arm’s overeager investors really got ahead of themselves in 2024, it seems. Sure, Arm’s AI-driven revenue growth is impressive. At the same time, Arm shares are too richly valued to buy with confidence now.
My point is that you don’t want to be a price chaser, as the risk-to-reward balance isn’t favorable. A sharp share-price pullback is very likely, and investors should brace for ARM stock to drop below $100. Then, it may be appropriate to gradually build a share position in Arm.
On the date of publication, David Moadel did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
