Down 16%, are Arm Holdings shares a no-brainer buy?

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If you pick up your smartphone, there’s a 99% chance that it wouldn’t turn on without the electronic architecture of Arm Holdings (NASDAQ: ARM). Its shares went public for the first time in eight years last week.

The tech firm is a British success story. It was founded in Cambridge in 1990 and has now become one of the world’s most important companies. Its designs are crucial to making electronics around the world run, including almost all smartphones.

It’s so vital, in fact, that huge names like Apple, Alphabet, Samsung, and Nvidia all invested in Arm last week. And with the shares on the market again, I have the chance to buy in too. So, what am I saying? This is a no-brainer buy, isn’t it?

Well, the first thing to point out is that this stock has nothing to do with the London Stock Exchange. The firm, still based in Cambridge, chose a US listing to attract a higher valuation. And in fairness, it’s hard to argue with the result. 

A huge valuation

Arm shares went public last Thursday at $51 before shooting up to $64 by close of play. The demand was high – understandable for such a great company – but the price doesn’t make much sense to me.

The firm had an earnings-per-share of $0.39 last year, a tiny figure compared to the $64 share price. On those numbers, Arm trades at over 100 times earnings. That’s a crazy valuation. 

If Arm attracted the same price while listed in the UK, it would comfortably find a home on the FTSE 100. Its market value of $60bn would even see it sneak into the top 10. Its P/E would be the highest on the index and by some distance too. 

Nvidia is an obvious comparison here. The US chip designer also has a P/E of over 100. The difference is Nvidia is growing revenue and income, whereas Arm isn’t. Arm’s net income actually declined last year. How can you justify a P/E over 100 with declining profits? I don’t think you can. 

A reason the price could be so high, and a cause for further concern, is the low supply of Arm shares. The float is only 9% of all the shares outstanding. With such a small number of shares available, I’d expect high volatility. 

We’ve seen this already with a 25% leap last week. Then, in yesterday’s trading, the stock dropped 16%. These ups and downs make the stock a risky buy, and with so few shares on the market, I expect more erratic moves over the coming weeks.

To make things worse, a small float can create a squeeze in price even from low demand. That could push the share price up in the short term, but lead to a crashing price if and when SoftBank – Arm’s owner – chooses to sell more of its stake. 

A buy?

The fundamentals just don’t add up for me here and I can’t see how the share price is justified. And that really is the rub. As much as I’d like to own the shares of such a great British enterprise, I won’t be buying at the current price.

The post Down 16%, are Arm Holdings shares a no-brainer buy? appeared first on The Motley Fool UK.

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Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. John Fieldsend has positions in Apple. The Motley Fool UK has recommended Alphabet, Apple, and Nvidia. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.