This overvalued growth stock makes Nvidia look cheap!

ARM Holdings is a growth stock that’s benefitted from the AI rally. Muhammad Cheema takes a look at whether this has been overdone.

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ARM Holdings‘ (NASDAQ:ARM) stock went public last September. Initially, the growth stock saw a decline of over 22% through to the end of October. However, since then, it’s rallied by over 225%.

This is a fantastic run, of course. But is it warranted? I’m not so sure.

Background

The British-based semiconductor company’s focused on developing and designing computer processing units (CPUs).

It’s also very successful. Its architecture is used by 99% of smartphones around the world. Furthermore, companies such as Nvidia use ARM Holdings’ architecture to make data processing units (DPUs). These are a new class of programmable processors used to improve the performance of artificial intelligence (AI) applications.

Looking at its recent quarterly results, we can also see the business is growing extremely well. Revenue has climbed 47% year on year to hit $928m. Meanwhile, net income has skyrocketed 7,637% to reach $221m.

Valuation concerns

Now I’m not disputing that ARM Holdings isn’t a great company, because its market dominance and results prove it is.

But in my eyes, it’s just way too overvalued.

For context, the company has a market-cap of $168bn. However, it’s trailing 12-month revenue’s only $3.2bn. This gives it a ridiculously high price-to-sales (P/S) ratio of 51.8. Moreover, its trailing 12-month earnings are only $306m, so its price-to-earnings (P/E) ratio’s 552.8. I don’t even know how to describe how big that is, if I’m being honest.

The recent run-up in its share price to produce these insane valuations is likely to do with the hype around AI.

Many companies in the space have seen their demand soar because of this. Just look at Nvidia, which has seen its quarterly revenue increase by 262% year on year, with net income also rising 628%.

However, I think ARM Holdings’ involvement in AI is a tad overstated. It acts more as a supplier to companies that use AI, as opposed to providing any AI functions itself.

Furthermore, even if it were to be treated as an AI stock, I still believe its valuation is a gross exaggeration of what it should be.

If we look at Nvidia again, we can see that it’s growing at a far quicker rate than ARM. Yet, its P/S and P/E ratios are only 39.6 and 74.1 respectively. This is still far below the level ARM’s trading at. Even then, many see Nvidia’s stock price as rather frothy.

Now what?

To make Nvidia’s stock look cheap is some feat. But it’s not necessarily a good one. The company’s growing at a far inferior rate, yet it’s far more expensive as far as valuation metrics are concerned.

Even with a high growth rate, I think it’ll take some time to grow into its current valuation. If I were to create a position in the stock, I’d wait for the price to drop.

That’s why I’ll be steering well clear of ARM Holdings’ stock for the time being.

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.

Muhammad Cheema 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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