Why are ARM shares so expensive?

ARM shares rose even further this week. Why are they so expensive? And could the inflated $71 share price still be a good buy?

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ARM (NASDAQ: ARM) shares are expensive and have just got even more so. The most recent rise puts the share price at $71 after being just $47 in October. 

If the Cambridge-based chip designer was listed in the UK, it would trade at one of the highest valuations on the London Stock Exchange.

Instead, ARM is listed on the other side of the Atlantic where stocks cost more. A lot more, in fact.  The S&P 500 average price-to-earnings (P/E) ratio is a whisker below 25 but some distance above the FTSE 100 at just 11. 

Yet even taking into account bigger American valuations, ARM still looks like its eye-wateringly pricey. It trades at over 150 times earnings and over 60 times forward earnings. 

Comparisons

It’s hard not to compare ARM to Nvidia (NASDAQ: NVDA). Nvidia is also in the electronic chips business and also flirts with triple-digit P/E ratios. Most importantly, Nvidia has been a terrific buy – up 14 times over the last five years despite seemingly crazy valuations.

There are two questions I’m interested in here. First, why are ARM shares so expensive? And second, could the firm enjoy Nvidia-like growth over the next few years? 

To circle back to Nvidia, the US giant’s growth has been driven by artificial intelligence (AI). Or rather, the prospect of a world where AI is at the heart of everything we do. 

Its share price surged thanks to investors wanting to get in on the ground floor of this technological revolution. 

Stolen a march

Nvidia has stolen a march on its competition. The firm’s $10,000 A100 microprocessor is used in 95% of current AI applications. Each time we type a question into Chat-GPT, chances are Nvidia’s GPUs are doing the grunt work. 

But Nvidia and ARM aren’t competitors. Without wanting to get too technical, the former’s focus is on making chips whereas ARM designs the architecture some chips are created with.  

In fact, Nvidia’s new GH200 Grace Hopper Superchip is based on ARM architecture and the US firm even bought a sizable stake in ARM at the IPO.

And while ARM has other routes to increasing earnings – notably a plan to bump up licensing fees on the use of its smartphone architecture – the expensive valuation comes, like Nvidia, with the prospect of an AI revolution. 

This is the core issue. If AI changes the world then 150 P/E ARM might look like a cheap buy. If the technology is a damp squib then weak profits would make the stock look even more expensive than it does now.

Unexplored territory

We’re in unexplored territory here, but my own view is cynical. AI applications might look exciting at first glance. I mean, who doesn’t want to ask a robot a question? Or create a picture out of thin air? 

But I haven’t seen any groundbreaking applications yet. It feels like we’re in an evolutionary phase rather than a revolutionary one with this technology.

I don’t doubt AI will improve or that one day machine learning will produce amazing things. But I’m investing for the next 10 or 20 years, not for another 100. I’ll keep ARM on my watchlist for now.

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.

John Fieldsend has no position in any of the shares mentioned. The Motley Fool UK has recommended 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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