Arm Holdings (ARM +2.31%) has long been influential in the semiconductor industry. Numerous top-chip companies depend on the chip designs it licenses.
With the recent launch of its initial public offering (IPO), investors have looked more closely at the company, and the stock has increased significantly since it began trading in September. While it could continue to rise over time, investors should not expect it to turn them into millionaires from a small investment. Here's why.
The size factor
The factor working against Arm Holdings in terms of its "millionaire-making" potential, at least for small investors, is its size. Despite the stock's short trading history, its market cap is $126 billion. That places it well into the range of large-cap companies, and if the stock's market cap doubled from current levels, it would become a megacap stock.
NASDAQ: ARM
Key Data Points
That situation does not work in favor of small investors. If one invested $10,000 in the stock today, it would need to grow by 100-fold to reach $1 million.
The problem is that also requires a 100-fold rise in the market cap, an increase that would take the market cap to $12.6 trillion dollars! To put that in perspective, the world's current largest cap, Microsoft, has a $3.1 trillion market cap, less than one-fourth that size.
Moreover, Arm investors did not benefit from the IPO culture in which Microsoft launched its IPO in March 1986. At that time, companies went public at much smaller sizes.
In March 1986, Microsoft began its history with a market cap of around $700 million. This means the stock has grown nearly 4,500-fold in its 38 years of existence. In contrast, Arm Holdings did not go public until the market cap was about $65 billion, making it unlikely that investors in Arm are going to see such returns, even over a 38-year period.
Added challenges
Furthermore, even if one could invest $100,000 in Arm stock, the path to $1 million could be tricky.
Indeed, Arm has built a lucrative business. As the demand for chips increases, particularly in the artificial intelligence (AI) space, chip companies will likely turn to Arm in increasing numbers.
Allied Market Research forecasts a compound annual growth rate (CAGR) of 6% for the semiconductor industry through 2031. Nonetheless, when it comes to AI chips, that CAGR jumps to 38% at least through 2028! Thus, Arm's chip designs will likely play a more critical role.
However, investors bid Arm's shares higher based on such expectations. Even when measuring valuation by the forward price-to-earnings (P/E) ratio, 80 times forward earnings prices the stock for perfection. Additionally, a price-to-sales (P/S) ratio of 43 confirms the overvaluation is not an anomaly. Hence, investors take on significant risk by buying at such levels.
Keep expectations in check with Arm stock
At today's stock price, Arm stock is probably not going to mint many new millionaires. Given Arm's large-cap size, millionaire status for small investors is likely out of reach.
Moreover, the stock's valuation will make such growth difficult for investors who can take six-figure positions. The current valuation will probably limit the upside in the near term, increasing the danger that investors will have to wait years for meaningful returns should the stock experience a meaningful downturn.
Arm Holdings will continue to serve as an essential company in the semiconductor industry. Nonetheless, if investors want to have a strong chance at earning outsized returns, they should look to other stocks.
