Semiconductors company Arm stunned Wall Street today as it plummeted to $162.51, marking a -3.0% change compared to the S&P 500 and the Nasdaq indices, which logged -1.0% and None% respectively.
ARM currently sits within range of its analyst target price of $156.77, which implies that its price may remain stable for the near future.
Surprisingly, analysts give the stock an average rating of buy, which shows that they believe prices could continue to move. Over the last year, Arm has lagged behind the S&P 500 by -10.9%, moving 9.1%.
Arm Holdings plc architects, develops, and licenses central processing unit products and related technologies for semiconductor companies and original equipment manufacturers rely on to develop products. The company is a technology company. Valuations in the technology sector are often very high, as investors are willing to overlook gaps in the fundamentals if they believe a company’s innovations can dominate or create new markets.
Arm's trailing 12 month P/E ratio is 213.8, based on its trailing EPS of $0.76. The company has a forward P/E ratio of 79.9 according to its forward EPS of $2.06 -- which is an estimate of what its earnings will look like in the next quarter. As of the third quarter of 2024, the average Price to Earnings (P/E) ratio of US technology companies is 30.01, and the S&P 500 average is 29.3. The P/E ratio consists in the stock's share price divided by its earnings per share (EPS), representing how much investors are willing to spend for each dollar of the company's earnings. Earnings are the company's revenues minus the cost of goods sold, overhead, and taxes.
To better understand the strength of Arm's business, we can analyse its operating margins, which are its revenues minues its operating costs. Consistently strong margins backed by a positive trend can signal that a company is on track to deliver returns for its shareholders. Here's the operating margin statistics for the last four years:
| Date Reported | Total Revenue ($ k) | Operating Expenses ($ k) | Operating Margins (%) | YoY Growth (%) |
|---|---|---|---|---|
| 2023 | 939,000 | 724,000 | 19 | 18.75 |
| 2022 | 824,000 | 654,000 | 16 | -52.94 |
| 2021 | 724,000 | 451,000 | 34 |
- Average operating margins: 23.0%
- Average operating margins growth rate: -25.2%
- Coefficient of variability (lower numbers indicate less volatility): 220.4%
Arm's financial viability can also be assessed through a review of its free cash flow trends. Free cash flow refers to its operating cash flows minues its capital expenditures, which are expenses related to the maintenance of fixed assets such as land, infrastructure, and equipment. Over the last four years, the trends have been as follows:
| Date Reported | Cash Flow from Operations ($ k) | Capital expenditures ($ k) | Free Cash Flow ($ k) | YoY Growth (%) |
|---|---|---|---|---|
| 2023 | -290,000 | 29,000 | -319,000 | -193.27 |
| 2022 | 423,000 | 81,000 | 342,000 | 64.42 |
| 2021 | 256,000 | 48,000 | 208,000 |
- Average free cash flow: $77.0 Million
- Average free cash flow growth rate: -40.9%
- Coefficient of variability (lower numbers indicating more stability): 0.0%
If it weren't negative, the free cash flow would represent the amount of money available for reinvestment in the business, or for payments to equity investors in the form of a dividend. While a negative cash flow for one or two quarters is not a sign of financial troubles for ARM, a long term trend of negative or highly erratic cash flow levels may indicate a struggling business or a mismanaged company.
Another valuation metric for analyzing a stock is its Price to Book (P/B) Ratio, which consists in its share price divided by its book value per share. The book value refers to the present liquidation value of the company, as if it sold all of its assets and paid off all debts. As of the third quarter of 2024, the average P/B ratio for technology companies is 3.91. In contrast, the average P/B ratio of the S&P 500 is 4.74. Arm's P/B ratio indicates that the market value of the company exceeds its book value by a factor of 31, so it's likely that equity investors are over-valuing the company's assets.
As of third quarter of 2024, Arm is likely overvalued because it has a higher P/E ratio than its sector average, a higher than Average P/B Ratio, and positive cash flows with a downwards trend. The stock has poor growth indicators because of its decent operating margins with a negative growth trend, and an inflated PEG ratio. We hope this analysis will inspire you to do your own research into ARM's fundamental values -- especially their trends over time.
