Summary

• ARM Holdings has made significant advances in AI, automotive, and mobile chip technology but faces financial and valuation challenges, leading to a "sell" recommendation.

• While revenue grew 39% YoY in Q1 2024 and profitability improved, a 52% QoQ drop in EBITDA raises concerns. The company's fiscal 2025 revenue guidance projects 18-27% growth.

• ARM's forward P/E, PEG, and EV/EBITDA ratios indicate the stock is overvalued compared to competitors, making it an unattractive investment.

• Technical analysis shows low trading volume and weakening momentum, reinforcing the "sell" recommendation despite ARM's long-term technological potential.

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ARM Holdings (NASDAQ:ARM) has made several technological advances in AI, automotive and mobile chip developments over the past year. However, despite this growth and development potential, financial, valuation and technical analysis tell a different story. In this article, I will share in detail why I am a “sell” on ARM.

ARM, which has been operating in the semiconductor and artificial intelligence fields for years, was included in the NASDAQ index at the end of last year. With this, ARM has gained 114% since the beginning of 2024.

Past Business Developments

Frankly, ARM’s financial performance in 2024 wasn’t bad at all. The company reported $939 million in revenue in Q1 representing a 39.11% YoY revenue growth. The biggest driver of this revenue growth was the increasing demand for ARM’s technologies in mobile devices, cloud and AI. The company’s latest release Arm v9 architecture, which focuses on improving performance and efficiency for AI applications, played a significant role in this revenue growth.

This chip also allows ARM to be present in the automotive sector. Based on this processor, ARM introduced the new Arm Automotive Enhanced series. The main purpose of these new chip designs, including the Arm Neoverse V3AE, is to enable manufacturers to develop advanced driver assistance systems much more effectively by enabling artificial intelligence in vehicles to work much more effectively.

In May 2024, ARM announced that it is developing several chips specifically to enhance AI capabilities in smartphones. This development will allow AI features integrated into smartphones to now work more efficiently with ARM chips. In addition, ARM is working to accelerate industry adoption of these chips by revising the delivery method for these development designs.

There have also been developments in ARM’s business strategy for 2024. Unlike previous years, the company has entered higher-value, lower-volume markets such as data center servers and AI accelerators. With this move, the company has begun to focus on the increasing demand for more energy-efficient solutions, especially in the AI ​​infrastructure built by companies such as Microsoft, Alphabet and Amazon.

In line with this, ARM is preparing to enter the AI ​​chip market directly, aiming to develop a prototype by spring 2025. In fall 2025 the company will establish an AI chip division to start mass production through contract manufacturers.

Generally ARM’s competitive advantage in the semiconductor and chip sector comes from its ability to produce very energy-efficient chips which are particularly for mobile devices and IoT devices. According to Forbes, the company has a 99% market share in mobile processor production, 40% in automotive processor production and 48% overall.

ARM's position in the technology sector looks really good. It seems like it will maintain this position in the long term and even develop it further. But does it offer investment opportunities for investors in the medium and short term? To find out, it is necessary to take a deep look at its financials.

Financials

In the third quarter of 2024, ARM reported net sales of $844 million which is a 4.7% increase from the previous quarter. This is not bad at all. However the company’s EBITDA came in at $108 million, which is a 51.99% decrease from the previous quarter and 169.67% increase from the same quarter of previous year. Therefore the stock outlook is slightly neutral to slightly positive. While revenue growth and annual EBITDA improvement are very good, the significant quarter-over-quarter decline in EBITDA is concerning.

ARM’s own forecasts suggest that the company’s fiscal 2025 outlook (which falls in calendar Q4 2024) is positive. The company projects annual revenues of $3.8 billion to $4.1 billion in fiscal 2025 representing an increase of 18% to 27% over the previous year. Additionally, it expects royalty revenue growth to be in the 20% range, lower than previous expectations, due to persistent inventory issues in the industrial IoT and networking sectors.

Net Profit Margin

ARM's revenue has been generally increasing since 2022 despite ups and downs. According to its shareholder letter ARM's net income has also increased from a $110 million loss to an quarterly profit of $107 million. Together with the growth of revenue this increase in profitability indicates that ARM is successfully controlling its costs. So it can be said that company's financial health appears to be in good shape. Comparing ARM's valuation indicators with those of its industry peers is necessary, though, because there might still be space for improvement.

Image created by Yavuz Akbay with data from tradingview.com (tradingview.com)

Valuation Ratios

Although its financials do not paint a perfect picture, ARM has become the stock that has increased the most among its competitors on an annual basis due to its technological developments. So, when ARM's ratios are compared to its competitors in the sector, is ARM in a suitable position for buying? Let's take a closer look.

Forward P/E

First of all, ARM's competitors were determined as Texas Instruments (TXN), Qualcomm (QCOM), Micron Technology (MU), Analog Devices (ADI) and Advanced Micro Devices (AMD), as determined by Seeking Alpha. When I took the average of the current forward price-earnings ratios of these companies, I calculated the level of 43.37. ARM's current price-earnings ratio of 177.61 is more than 300% above this average. This makes the stock unimaginably expensive compared to its substitutes.

Image created by Yavuz Akbay with data from seekingalpha.com (seekingalpha.com)

Forward PEG

I also think it is useful to look at the PEG ratio analysis, which also includes company growth. When the average of the most recent forward PEG ratios of the stocks is taken, it is calculated as 3.17. Considering that ARM has a PEG value of 2.67, this actually shows that ARM is quite acceptable cheap. However, there is a subtle detail here.

If you look at the table, you can see that TXN has a PEG value of 10.80, which deviates too much from the average. Therefore, I think that this value misleads the sector average calculation. If the average is calculated by subtracting this value, the average drops from 3.17 to 1.65 and therefore it turns out that ARM is actually trading more expensively than the sector average according to the PEG ratio. Since I am confident that this calculation is much more accurate, I will make an analysis based on this calculation.

Image created by Yavuz Akbay with data from seekingalpha.com (seekingalpha.com)

As a result, according to PEG and P/E ratios, ARM is trading at a much higher price than it should be. Therefore, it does not seem like it's a good place to buy for ARM.

Forward EV/EBITDA

I would like to confirm that ARM is overvalued with a ratio that takes into account the company value, such as EV/EBITDA. When the EV/EBITDA (forward) ratios of ARM's substitutes are averaged, the value is 20.73. Although a healthy EV/EBITDA value that we normally look for when investing in a stock is below 10, since the sector average is 20.73, it can be said that EV/EBITDA values ​​below this level are also slightly discounted. However, we see that ARM's EV/EBITDA value is almost 4 times higher than this average at 75.45. Therefore, it cannot be said that the stock is at a good point to invest with this ratio.

Image created by Yavuz Akbay with data from seekingalpha.com (seekingalpha.com)

Technical Analysis

When analyzing a stock technically, I use both the price action method and indicators. In this analysis, I will use the Hodrick-Prescott filter to determine the trend of the stock and the MACD to determine the momentum of the stock.

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When looking at ARM historically, it is possible to say that the stock has been hovering around $141, especially since August. Therefore, an upward or downward trend cannot be determined. Similarly, when looking at the HP filter, the price diverges around the filter in the range of negative and positive 12%.

In addition to this stagnant state of ARM, there is a symmetrical triangle structure that has been ongoing since July. The support and resistance points of this triangle have been tried many times, but ARM has not been able to break the triangle either up or down.

When the 20-day moving average of the volume is taken, a volume value of 4.39M is determined. ARM's trading volume has never been this low. This clearly explains why ARM has been hovering around the same price since August.

Low volume does not always lead to a decline, but when the decrease in volume, the price not being able to rise for months and the gradual decrease in momentum are combined, a very clear "sell" indicator emerges.

Risks and Challenges

There are several risks that could challenge or reverse my "sell" decision based on my extensive analysis. First, if ARM's developments in AI accelerators and automotive AI systems are much faster or more successful than expected, revenue and profitability could exceed current estimates, sending the stock higher. In addition, sudden increases in demand for mobile devices or chips could lead to unexpected royalty growth. A broader risk is general competition risk. We saw this year how Intel (INTC) fell behind in its processor competition with AMD with just a small mistake. Similarly, mistakes made by ARM's competitors who produce chips on the x86 architecture could increase demand for ARM and cause the stock to rise.

Conclusion

In conclusion, ARM’s technological advances in AI, automotive and mobile chip design position it as a very successful player in the semiconductor industry in the long term, while its poor financial and valuation metrics signal a short-term downside in the stock. ARM is a very expensive stock in comparison to its peers despite the company's over average profitability, valuations are far higher than the sector. When the stock is analyzed technically, low trading volume, weakening momentum and a long-term symmetrical triangle pattern indicating a lack of direction are other factors supporting this bad outlook. The best course of action for an investor given these findings is to take a "sell" position on ARM stock.