A check of IPO filings over the past few years shows a clear indication that companies are much more reluctant to go public. That reluctance is likely tied to a tumultuous market of the past 18 months that put an end to Wall Street's pandemic-related boom.
While the trend is to steer clear of initial public offerings (IPOs) at the moment, not all companies are being trendy. In fact, chip design company Arm Holdings is set to burst onto the IPO scene sometime in the next two weeks. When it does, Arm's launch could be this year's biggest technology IPO.
The rumor is Arm is seeking an estimated $50 billion to $55 billion valuation when it begins trading on the Nasdaq. While the hype is building for this company and what it can accomplish, there is reason to believe this could be a situation in which Arm's greatness doesn't end up translating to outsized investment returns.
For those who are wary of the hype, there's an underrated stock that is arguably as important to the semiconductor industry but has a far more reasonable price tag. Here is what you need to know.
What are IPO investors getting for their money?
Arm Holdings plays a crucial behind-the-scenes role in the semiconductor industry. The company developed and owns Arm CPU architecture, a framework on which processor chips are built.
It's similar to a homebuilding code. Lots of companies build houses, and they all have differences. However, all builders follow general rules in how houses are built, ensuring they all meet a basic level of safety and performance.
Roughly half of the world's processor chips use Arm architecture, and Arm makes money on the royalties that chip companies pay to use its intellectual property. Since semiconductors are the building blocks of technology, the likely increase in demand for chips for industries like autonomous driving and artificial intelligence (AI) are all potential growth opportunities for Arm over time.
It's an essential company in a growing industry, but that's not lost on the market. The company did $524 million in net income in its fiscal year ending March 31. If the stock achieves a $55 billion valuation when trading begins, investors might pay a price-to-earnings ratio (P/E) of roughly 105 to own shares. That's a steep valuation that could disappoint investors if the company can't live up to expectations.
This other company is just as crucial to the industry
So, why not look for a better deal on a business that plays a crucial role in semiconductors? ASML Holding (ASML 2.04%) designs and sells lithography equipment to manufacture semiconductors. These machines are vital for making advanced chips.
ASML has an estimated 90% market share in the lithography market, making it an indispensable vendor in bringing newer and better chips to market.
ASML's equipment makes chips for end markets, including personal electronics, automotive applications, industrial uses and automation, data centers, and more. The company estimates that total semiconductor demand will grow by an average of 9% annually through the remainder of the decade. Already, ASML has doubled its annual revenue since 2020.
ASML's business is generating a whopping 56% return on its invested capital, a strong indicator that the company has pricing power, which makes sense as the market leader in its industry. Analysts believe the company's earnings will grow by an average of 24% annually over the long term.
ASML revenue (TTM) data by YCharts. TTM = trailing 12 months.
But unlike Arm Holdings, the stock doesn't come at such a sharp valuation. ASML is trading at a forward P/E of almost 31. The company's 1.3 price/earnings-to-growth (PEG) ratio implies that the stock is very reasonable, given the company's expected earnings growth.
ASML is a wonderful business in a growing industry, trading reasonably. What's not to like? Don't let shiny new stocks like Arm distract you from a great opportunity staring you in the face. Consider digging into ASML as part of your diversified portfolio.
