Artificial intelligence (AI) has the power to revolutionize all types of technology applications. The key pieces that put the fabric of AI together include semiconductors. High-performance graphics processing units (GPUs) play an important role in generative AI, machine learning, and quantum computing.
Be at the center of the AI semiconductor landscape Nvidia And modern micro devices. Both companies have a clear lead over smaller providers and demand for their respective chips is above average.
Last year, Nvidia stock turned $1,000 into more than $3,000, and investors may be worried they've missed the boat. If you look for lesser-known names, you might find what you're looking for Arm stocks (NASDAQ:ARM). The company went public last year and has flown under the radar since then, overshadowed by other opportunities in the semiconductor space.
But earlier this month, Arm beat Wall Street's expectations in its earnings report for its fiscal third quarter ended Dec. 31. After reporting earnings on February 7, Arm shares nearly doubled over the next three trading days.
The price jump is breathtaking, but is it worth buying the stock now?
Arm Holdings simply exceeded expectations
One thing needs to be made clear right from the start: the semiconductor industry is cyclical. Demand for chips will fluctuate and fluctuate, and supply chain challenges and even geopolitical concerns may add additional complexity.
As a result, semiconductor companies can experience dramatic fluctuations in sales, margins and profits. Arm is no stranger to this dynamic, having posted mixed financial and operating results in recent years.
But the semiconductor industry is in full swing right now, and Arm is a beneficiary. For the quarter ended Dec. 31, the company reported revenue of $824 million – an increase of 14% year-over-year. This significantly beat Wall Street's consensus estimate of $761 million.
The story goes on
Perhaps even better: Arm also showed a strong performance overall. The company reported adjusted earnings per share (EPS) of $0.29, narrowly beating the high end of its previous forecast. This beat analyst estimates of $0.25 per share.
What may have made the stock go parabolic was management's guidance. For the current quarter, the company is expected to generate revenue between $850 million and $900 million. Once again, Wall Street's consensus estimate was well below that range. Management's forecast was more than $100 million above analysts' estimates.
Arm is benefiting from long-term tailwinds that are driving the overall semiconductor market. And while this dynamic is currently good for business, the stock is being bought up.
Image source: Getty Images.
Valuation is a problem
At the time of writing, Arm's market cap has more than doubled since its earnings release.
With trailing 12-month sales of $2.9 billion, the company trades at a price-to-sales (P/E) ratio of around 40. That's the same as Nvidia's P/E ratio – and Nvidia is a much larger company. faster growing company with significantly more market share for AI chips.
While Arm's management deserves credit for the company's impressive performance, there is no connection between the stock price and the company's valuation compared to its underlying results (and compared to peers).
Is Arm stock a buy now?
To be clear, I don't think Arm is a bad investment decision. However, there seems to be a lot of momentum at play in the current valuation. My guess is that short-term traders bought the stock hoping to make a quick profit as AI stocks continue to rise. Participating in such a movement carries enormous risk and may result in you bearing the responsibility.
If you're interested in adding semiconductor names to your portfolio, Arm could be a good option beyond the mainstream options. However, buying the stock now at an inflated price comes with significant disadvantages.
In my opinion, the wisest thing would be to keep an eye on the company's performance and assess whether management is executing things. If the company continues to beat its own forecasts and exceed analysts' expectations, a higher valuation could be justified.
But at the moment I think the stock is overvalued – it may even be entering meme territory. I think there are safer alternatives to deal with AI and especially chips. Arm could be a solid option in the long term, but I would stay away from the stock for now.
Should you invest $1,000 in Arm Holdings now?
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Adam Spatacco holds positions at Nvidia. The Motley Fool has positions in and recommends Advanced Micro Devices and Nvidia. The Motley Fool has a disclosure policy.
Missed Nvidia? Be careful before looking at this other semiconductor stock. was originally published by The Motley Fool