Should I buy ARM Holdings shares after the IPO?

Edward Sheldon looks at whether ARM Holdings shares are a good investment after the semiconductor company’s blockbuster IPO this week.

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After around seven years as an unlisted company, it’s now possible to buy ARM Holdings (NASDAQ: ARM) shares again. Yesterday (14 September), the British semiconductor company came back to the public markets via an Initial Public Offering (IPO).

Now, as a long-term growth investor, I’m very bullish on the semiconductor industry as these items, or ‘chips’, are essentially the brains of all modern electronic devices. Should I buy ARM shares for my portfolio? Let’s discuss.

The IPO

When I first heard that ARM was going to IPO, I was excited.

Before being taken private by Japanese conglomerate SoftBank in 2016, the company had been a phenomenal long-term investment. Between 2006 and 2016, for example, it was a ‘10-bagger’.

Meanwhile, chip powerhouse Nvidia tried to buy the company last year (but failed due to regulatory challenges).

To my mind, Nvidia’s CEO Jensen Huang is one of the most clued-up CEOs on the planet. If he wanted to buy ARM, it suggests that the company has a lot going for it.

Potential for growth

When I started researching into the IPO, however, my enthusiasm for the stock waned a little.

Don’t get me wrong – this is a very exciting company. It’s the industry leader in CPUs (computer processors).

These are used to power smartphones (its technology can be found in over 99% of the world’s smartphones), computers, smartwatches, data centres, networking equipment, vehicles, and other electronic devices.

And looking ahead, there’s plenty of growth potential due to the company’s exposure to cloud computing, electric/autonomous vehicles, and artificial intelligence (AI).

On the AI front, ARM notes in its IPO prospectus that its CPUs already run AI workloads in billions of devices, including smartphones, TVs, cars, and data centres.

Companies it’s working with here include Alphabet, Cruise, Meta, and Nvidia.

Overall, it defines its total addressable market (TAM) as all chips that can contain a processor. And it believes its TAM is worth over $200bn today.

High valuation

My issue though is the current valuation.

The IPO valued it at around $55bn. But as I write this late on 14 September, the market cap stands at around $64bn.

That seems excessive to me.

For the fiscal ended 31 March 2023, ARM’s total revenue was $2,679m (versus $2,703m a year earlier).

That puts the trailing price-to-sales ratio at about 24, which is high.

Even if we assume the company sees 30% revenue growth this financial year, the multiple is still quite elevated at around 18.

That’s significantly higher than most semiconductor companies’ price-to-sales ratios (excluding Nvidia).

Other risks

And the valuation isn’t the only risk.

Some investors have doubts about whether the company can see success beyond the smartphone world.

It’s not clear that Arm is a critical player in most of the areas of expansion. I don’t see it as having a particular area of strength in AI-type developments,” said ex-Scottish Mortgage Investment Trust portfolio manager James Anderson recently.

The group’s exposure to China is another issue. China accounts for around a quarter of its revenues.

My view

Given the high valuation, I’m going to hold off on buying ARM shares for now.

There’s a good chance I will buy the stock in the future.

But for now, I think there are better growth shares to buy.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Ed Sheldon has positions in Alphabet, Nvidia, and Scottish Mortgage Investment Trust. The Motley Fool UK has recommended Alphabet, Meta, 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.

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