Arm Holdings Falls 40% on Selloff, Is It a Solid Buy Now?

Semiconductors Semiconductors are among the most essential technologies on the planet, enabling everything from thermostats to smartphones to autonomous vehicles. Today, artificial intelligence (AI) demands even higher performance. These high-performance products are so important that there are geopolitical tensions between the United States and China over import and export bans and Taiwan, where most of the world’s semiconductors are made.

Due to strong demand and tailwinds, many stocks in the sector, including Firearms (NASDAQ: ARM)took off in 2024. The enthusiasm pushed Arm’s valuation to sky-high levels, but the recent market sell-off has sent Arm down nearly 40% from its recent highs, as shown below.

Arm is a special kind of semiconductor company, and that’s a huge advantage. Let’s take a look at what it does and see if the crisis is a golden opportunity.

Why is Arm’s business model so desirable?

Arm Holdings is a semiconductor company that doesn’t actually produce semiconductors. Instead, Arm designs the “infrastructure” for central processing unit (CPU) chips that his customers love AppleSamsung, Alphabet, NvidiaAnd Semiconductor Manufacturing in Taiwan (NYSE: TSM)used as a building block. Arm then receives payments for licenses and royalties based on the number of products sold. The cumulative number of Arm-compatible chips is 287 billion, and they capture 99% of the global smartphone market.

Because Arm is not a manufacturer, its financial results resemble those of a software company due to three characteristics:

Arm doesn’t need to invest a lot of capital in factories and equipment (called capital expenditures) like other semiconductor companies do. Arm spends less than 5% of its revenue on capital expenditures, while Taiwan Semiconductor, for example, regularly spends more than 30%. Because of this low capital expenditure, Arm converted 20% of its revenue, or $709 million, into free cash flow over the past 12 months.

On a gross margin basis, Arm compares favorably to software companies like Palantir Technologies (NYSE: PLTR) and is well ahead of other semiconductor stocks, as shown below.

A high gross margin generally means that a company can convert higher sales growth into net profits.

Finally, Arm’s revenue isn’t just recurring; it also leverages existing products. When Arm creates a new product for a new use case, its older models continue to sell. As shown below, this allows the company to “stack” new sales on top of old ones.

The story continues

Royalties on older products are very important to the bottom line because the research and development costs were paid years ago. This business model is great in terms of profitability.

Is Arm Holdings Stock a Buy Now?

With its attractive business model and tailwinds, it’s no wonder investors have driven the stock price up from $51 to over $180 per share, compared to its September 2023 IPO price. However, the valuation remains significant. At its peak, Arm stock traded at $100.