Last year, chip design company Arm Holdings (NASDAQ: Arm) was one of Wall Street's hottest initial public offerings. Shares have corrected recently after soaring out of the gates on hype over its artificial intelligence (AI)-related tailwinds. Today, the stock trades nearly 30% off its high.
The company designs products that serve as the foundation of modern semiconductors; roughly half of the world's chips use designs owned by Arm. An increasingly digital world warrants more chip demand, meaning more Arm royalties. But is the stock already priced too high despite its recent stumble?
Here is what you need to know.
Market share momentum points to a competitive edge
Arm develops semiconductor architecture, the foundational design for chips. Whenever companies build a chip based on an Arm design, it gets a small fee or royalty. This is a high-margin business model with gross profit margins in the high 90% range.
Management expects the business to generate about $3.1 billion in revenue this year and be profitable. Analysts estimate the company will earn roughly $1.20 per share this year, pricing the stock at approximately 69 times its expected fiscal year 2024 earnings.
That's the price. Is it a good value for investors? That requires a look into Arm's growth prospects.
The company reported its market-share trends for various end markets while going public. This is important because investors could expect future revenue growth if Arm gets a bigger slice of the chip pie, especially if that pie (the chip market) grows.
Market share trends from 2020 to 2022 include:
| End market | 2020 Market Share | 2022 Market Share | 2022 Market Size | Est. market growth rate through 2025 |
|---|---|---|---|---|
| Mobile applications processors | 99% | 99% | $29.9 billion | 6.4% |
| Consumer electronics | N/A | N/A | $46.9 billion | 4.3% |
| Industrial IoT and embedded | 58.4% | 64.5% | $41.5 billion | 6.7% |
| Networking equipment | 18.8% | 25.5% | $17.2 billion | 1.8% |
| Cloud computing | 7.2% | 10.1% | $17.9 billion | 16.6% |
| Automotive | 33% | 40.8% | $18.8 billion | 15.7% |
| Other infrastructure | 9.1% | 16.2% | $12.7 billion | 2.7% |
Chart by author. Data sourced from Arm Holdings F-1 filing. IoT = Internet of Things.
Investors looking for Arm's competitive advantage should look no further than its massive gains in market share over such a short time frame. For long-term growth, the picture is less certain. Consistent double-digit revenue growth will likely require continued gains in market share because most of Arm's primary markets are growing by the low to mid-single digits.
Arm has proved capable of that, but market share gains are not guaranteed to last forever. As Arm gains ground, competitors might become more aggressive in protecting their share.