Could the ARM (NASDAQ: ARM) share price repeat its massive leap since last October in the next 12 months?
This British company’s products like its v9 architecture have positioned it at the heart of the artificial intelligence revolution. With the hype around AI becoming very intense, ARM shares leapt from $48 last October to $149 this February.
After tripling in just a few months, the shares have cooled off. Are they now an attractive buy? I think there are three ways this could go.
The bubble pops
First, let’s address the bear case. The AI bubble pops. Valuations of stocks like ARM, Nvidia or Palantir come back down to earth. ARM in particular would be hurt with a forward price-to-earnings ratio (P/E) of 91 that might fall to the average of the ‘Magnificent 7’ of around 30.
We’ll need to pair this with earnings to get a hypothetical price. Analysts think earnings per share (EPS) will rise at 27% over the next year. If the AI impact slows, then I’ll assume earnings from ARM’s chip designs will still rise, but more slowly too. Let’s go with a 15% increase in EPS.
All things being equal, the shares would be valued at $38 at the end of the fiscal year. Such a big drop highlights the risks of investing in high P/E stocks. Simply, there isn’t much margin of safety.
AI resilient
Next, let’s look at how things might go if AI progresses at a smooth rate. In this case, I’d expect earnings projections to be met as the demand for chips worldwide continues.
I’ll also assume ARM retains its forward P/E of 91.
In this case, the shares could be valued at $169. That’s a 27% increase on the current share price which sounds pretty good but keeping such a high valuation is a pretty tough task.
The tech hits the mainstream
Now, let’s focus on the upbeat angle. In this scenario, AI hits the mainstream. Practical applications have been found using ARM-related designs and maybe even a new AI breakthrough has been discovered.
In this case, ARM beats earnings much like it did in the last two quarterly results. I could even assume the rapid pace of AI adoption pushes the forward P/E up to 100.
By my (admittedly quite rough) calculation, ARM shares could be valued at $256 at the end of the fiscal year. So even in these outrageously ideal conditions, the shares aren’t likely to triple again.
The modest return from even a very optimistic scenario paints a clear picture — AI stocks have massive amounts of future growth already priced in. With a lack of mainstream applications, particularly those people pay a lot of money for, share prices seem toppy to me.
My opinion on ARM? I love the company, but I can’t get on board with the valuation. I won’t be buying the shares.
The post Will the ARM share price triple again? appeared first on The Motley Fool UK.
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The Arm share price is rocketing! Should I scramble to buy the stock or wait?
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.
