Arm's price-to-earnings ratio actually exceeds that of Nvidia. How can it attract investors if revenue does not increase?

On September 14, local time, Arm, the world's largest IPO this year, was listed on Nasdaq. Its market value soared to more than 65 billion US dollars overnight, and its stock price soared by more than 25%, winning cheers from the market. Calculated based on the diluted market value of the latest share price, Arm’s price-to-earnings ratio in the past 12 months is close to 170 times. The latest price-to-earnings ratio of Nvidia, the chip giant with a market value of one trillion US dollars, is only 110 times.

The price-to-earnings ratio indicator reflects the market's expectations for the company's future earnings. The higher the P/E ratio, the higher the market's expectations for the company's future earnings.

The Invesco Semiconductor ETF's average price-to-earnings ratio calculated on the performance of the 30 largest U.S. chip companies is only 21 times.

NVIDIA is an exception. The company has benefited significantly from the demand for accelerated computing chips driven by generative AI. It has doubled its revenue in the past quarter and is expected to surge 170% in this quarter.

But for Arm, which has experienced a slight decline in revenue over the past year without any growth, such a high price-to-earnings ratio makes it incomprehensible to some market participants. They think it's hard to justify a P/E ratio of more than 100 times for a company that's not growing.

A person who has been investing in the chip field for a long time told China Business News: "Arm's profits are still very impressive. The company is telling the capital market that it will develop some new designs to restart growth, thus raising investors' expectations."

Arm has generated US$400 million in profits over the past four quarters, but its gross profit margin is as high as 96% and its operating profit is 25%, which is higher than most companies in the chip industry.

Sheng Linghai, an analyst at research firm Gartner, told China Business News that the reason why Arm can achieve such a high gross profit margin is mainly because most of the company's revenue comes from patent licensing fees and it does not need to provide hardware production. This is an essential difference from other chip manufacturers.

"For chip IP companies, the cost is mainly the salary cost of developers, while other chip manufacturers also need physical costs such as manufacturing and raw materials, which will reduce profit margins." Sheng Linghai told China Business News.

Nvidia's latest quarterly financial report shows that its gross profit margin reached 70%, a significant increase from the 44% gross profit margin in the same period last year, while Intel and AMD's gross profit margins were 36% and 46% respectively.

For a hardware manufacturer, a gross profit margin of 70% is also very rare. Industry insiders believe that NVIDIA is more like a "software company disguised as hardware."

Sheng Linghai told China Business News: "Nvidia actually not only sells chips, but also sells modules. Coupled with its complete ecosystem, it has created a special case in the chip industry."

For Arm, future market share growth may depend largely on the overall economic environment. Arm said in its IPO filing that it expects the addressable market for its designed products to grow to $246.6 billion by 2025 from $202.5 billion last year, an annual growth rate of just 6.8%.

Investment strategists believe that the reason for the market's optimism about Arm is that even if the company's revenue declines slightly, as long as it is expected to maintain strong profit margins, the company is still worth investing in.

"In the context of the industry as a whole paying more attention to cost control, investors will also pay more attention to corporate profits, but they do not have such high requirements for growth scale." DBS Bank (China) investment strategist Deng Zhijian told China Business News.

On the other hand, investors also believe that Arm is "relatively safe" because it has a large number of giant technology companies including Apple, Google, Nvidia and others as cornerstone investments. And given that Arm’s technology supports most of the key electronic products, it becomes a “unique” company.

Nvidia founder and CEO Jensen Huang supported the company that had planned to acquire it in the Arm roadshow video. He said: "Without Arm's unique licensing system and technology, our acceleration chip processor would be difficult to achieve."