The Arm Holdings (NASDAQ: ARM) share price shot up in after-hours trading last night (7 February). At one stage, it was up an incredible 40%.
So, what’s behind this explosive move? And should I scramble to buy the chip stock for my portfolio or wait for a better opportunity?
Q3 results boosted by AI
The reason the share price spiked was that results for the third quarter of fiscal 2024 were much better than expected.
For the quarter, revenue came in at $824m (+14% year on year) versus $761m expected. Meanwhile, adjusted earnings per share (EPS) came in at 29 cents (+32%), well above the consensus forecast of 25 cents.
We had an outstanding Q3 delivering record revenues and exceeding the high end of our guidance ranges for both revenue and non-GAAP EPS.
Arm Holdings Q3 letter
Forward guidance was also very strong. For the current quarter, Arm said it expects EPS of between 28 cents and 32 cents on sales of $850m to $900m. Going into the print, analysts had been expecting earnings of 21 cents per share on sales of $780m.
Meanwhile, for the full fiscal year ending 31 March 2024, Arm expects to generate revenue of between $3.16bn and $3.21bn along with adjusted earnings of $1.20 to $1.24 per share. Analysts had been expecting $3.05bn and $1.07 per share.
It’s worth pointing out that Arm’s growth is being driven by new artificial intelligence (AI) products and applications. As customers like Nvidia aim to design new chips for AI work, the company is generating higher royalties.
“We’re seeing more interest in newer designs and newer technologies by customers due to interest in AI,” CFO Jason Child told Reuters. “It’s real. Folks are actually buying and licensing that technology,” he added.
Should I buy now?
When I covered Arm after its Initial Public Offering (IPO) last year, I said that there was a lot to like about the company.
And today, my view is the same. I think it has a huge amount of potential in our increasingly digital world.
It is impossible to build an intelligent electronic device without a CPU, and more chips with Arm CPUs have been delivered in the last decade than any alternative.
Arm Holdings Q3 letter
Given the growth potential, I would like to own the stock one day.
However, at present, I can’t justify the valuation here.
In the pre-market, Arm shares are trading at $93. So, that puts the forward-looking price-to-earnings (P/E) ratio at 76 if we take the mid-point of the EPS guidance ($1.22)
That’s really high for a chip stock. And it adds a lot of risk to the investment case. For reference, Nvidia (which is quite expensive itself) has a P/E ratio of 33.
Ultimately, I think there are better chip stocks to buy for my portfolio right now. Some examples include Lam Research, Applied Materials, and KLA Corp.
These companies – which specialise in chip manufacturing equipment – are likely to benefit from the growth of AI too. However, they all have P/E ratios of less than 30. So, I see them as more attractive from a risk/reward perspective.
