Share-price momentum is fine, but it’s not the be-all and end-all. Sensible investors should also consider a company’s valuation, and Arm (NASDAQ:ARM) is a perfect example of this. Plus, Arm’s optimistic revenue outlook could be a setup for disappointment and, hence, might just be the pin that pops the ARM stock bubble.
Of course, much of the enthusiasm surrounding arm is associated with the artificial intelligence hype. Some folks who missed the Nvidia (NASDAQ:NVDA) stock rally are undoubtedly looking for a second chance.
Since Arm specializes in AI chip designs, stock traders might hope that Arm will be the “next” Nvidia. However, that ship has already sailed and the prospect of a steep share-price pullback must not be dismissed.
Arm’s Valuation Will Shock You
Along with being involved in the AI-hardware industry, Arm is a hot topic on Wall Street because market darling Nvidia invested in the company. That’s already known and priced into ARM stock by now, though.
There’s also some excitement surrounding Arm because the company’s initial public offering is still fairly recent. Momentum focused traders may be entranced by the stock’s moonshot.
Believe it or not, ARM stock traded at just $51 at its IPO but recently surpassed $130. That’s a share-price double and then some, but it raises the question of whether Arm is over-hyped and over-valued now.
Alarmingly, Arm’s GAAP-measured trailing 12-month price-to-earnings ratio is 1,555.4x. This makes the relentlessly vaunted Nvidia, with its 72.96x P/E ratio, look like a rock-bottom bargain.
Can Arm Live Up to Its Own Expectations?
Some publications will declare that ARM stock and/or other AI investments are in a bubble; others will dispute this. Either way, Arm now has to live up to its own high expectations, and that won’t be an easy task.
For the current quarter, Arm expects to generate revenue in the range of $850 million to $900 million. Meanwhile, the analysts’ consensus estimate only called for $778 million in quarterly revenue.
At the midpoint of Arm’s projected current-quarter revenue range, this would represent 38% year-over-year growth. That’s a tall order, and judging by ARM stock’s massive post-IPO rally, it seems like the market already bought into Arm’s high hopes.
To provide some perspective, Arm’s revenue for its most recently reported quarter grew 14% year over year to $824 million. So, Arm has to accelerate its sales growth at a rapid clip just to meet the midpoint of its own guidance range.
ARM Stock Is Pricey, and the Outlook Is Dicey
The word “bubble” is probably overused in the financial media. Yet, I encourage you to refer back to Arm’s P/E ratio and decide for yourself whether the “bubble” descriptor applies here.
It’s fine to look for the “next” Nvidia stock, but don’t lose your common sense. Every known fact, including Nvidia’s investment in Arm, has already been priced in.
Plus, Arm now has to deliver home-run revenue in the current quarter. All of this indicates that ARM stock is susceptible to a steep pullback, so this definitely isn’t a good time to buy shares.
On the date of publication, David Moadel did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.