It's no secret that Arm Holdings (ARM 4.11%) stock benefitted from the artificial intelligence (AI) boom. Since its IPO at $51 per share in September, the stock price has nearly tripled, with shares trading for $146 on Monday. One analyst suggests the price spike put Arm's valuation into rarified territory and pullback is coming.
New Street Research analyst Pierre Ferragu downgraded Arm to neutral (hold) from buy while maintaining a one-year price target of $110. That represents a potential downside for investors of 26% compared to the stock's closing price when the price was reported.
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AI boom or bust?
Ferragu's math is simple. In fiscal year 2028, New Street is modeling for Arm to generate earnings before interest and taxes (EBIT) of $3.8 billion, which the firm suggests is roughly 5% above analysts' consensus estimates. With that as a backdrop, the analyst argues that "even with a generous 40x multiple on our above-consensus expectations," he can't justify buying Arm stock at any price above $110.
The analyst's math is sound but the big picture is more complicated, and the numbers need context. Ferragu's financial model is based on what we know today, which could mean very little in the months and years to come.
Arm just boosted its full-year revenue forecast by 5% at the midpoint of its guidance and its adjusted earnings per share (EPS) by 16%, citing surging demand for generative AI. No one knows for sure just how high the demand for AI will go. With adoption on the rise, analysts are flat-out guessing about what the future holds.
For example, if someone suggested in early 2023 that Nvidia would soon be generating successive quarters of triple-digit revenue and EPS growth, they would have been laughed out of the room.
I can't say with any certainty where Arm stock will be over the coming year, but if the AI boom continues -- and I believe it will -- I suspect the stock price will be much higher than where it is today.
