It's the End of an Era for Arm Holdings. Should Investors Be Worried?

Shares of Arm Holdings (ARM 8.43%) were down in pre-market trading Thursday morning despite a first-quarter earnings report that beat analyst expectations. Revenue shot up 39% year over year in the period ended June 30, driven by multiple high-value license agreements and a 17% rise in royalty revenue. The company estimates that 28.6 billion Arm-based chips were shipped in fiscal 2024, spread across the smartphone, embedded, automotive, cloud, and consumer electronics markets.

Despite Arm’s solid results, there were a few things that may be worrying investors. First, the company’s outlook wasn’t quite as rosy as analysts expected. Arm expects to generate between $780 million and $830 million in revenue during the second quarter of fiscal 2025, compared to a consensus analyst estimate of $812.75 million. An adjusted earnings-per-share (EPS) guidance range of $0.23 to $0.27 also fell a bit short of the $0.28 analysts anticipated.

Second, Arm has stopped reporting the total number of Arm-based chips shipped each quarter. When a company suddenly stops reporting a key metric, that can sometimes be a red flag. In the fourth quarter of fiscal 2024, the number of chips shipped plunged 10% year over year to 7 billion.

With Arm no longer reporting chip volumes, should investors be worried about the company’s future?

The disclosure change makes sense

Arm explained in its letter to shareholders that the number of chips shipped was useful in the past as a measure of acceptance of the company’s products. However, as Arm pushes into high-value, low-volume markets like data center CPUs and artificial intelligence (AI) accelerators, this metric becomes less meaningful.

Arm’s royalties are based on the value of the chips that include its technology. In the Internet-of-Things (IoT) and embedded market, where an enormous number of low-value Arm-based chips are shipped each year, driving higher volumes is the path to higher royalty revenue. In the data center CPU market, where annual industrywide chip volumes are measured in the tens of millions, even if Arm were to win a dominant market share, chip volumes would be a drop in the bucket compared to Arm’s more mature markets.

However, markets like data center CPUs can still drive significant growth in royalty revenue because the value of chips can be multiple orders of magnitude higher. High-end server CPUs from Intel or AMD can cost many thousands of dollars each. As Arm makes progress in these high-value markets, even a relatively small number of chips can generate meaningful royalty revenue.

While investors should always be wary when a company stops reporting an important figure, Arm’s decision to stop reporting chip volumes makes sense given the evolution of its business.

A pricey stock, regardless

Arm has a massive long-term growth opportunity as it maintains its dominance in mature markets like smartphone chips and embedded processors while expanding into PCs, server CPUs, AI accelerators, and other higher-value chips.

However, the stock already prices in an incredible amount of growth. With a market capitalization of around $150 billion before the post-earnings decline, Arm is valued at nearly 40 times the midpoint of revenue guidance for fiscal 2025, and more than 90 times the midpoint of adjusted earnings guidance.

It will be difficult, and perhaps impossible, for Arm to grow quickly enough to justify these sky-high valuation multiples. Arm won’t dominate these new high-value markets in the same way it dominates the market for smartphone chips. The company faces intense and entrenched competition.

So while investors needn’t worry about Arm’s decision to stop disclosing chip volumes, they should be very worried about the valuation.