Does Arm Stock Deserve Its Rich Valuation?

We don’t invest in stocks, we invest in companies. The arbitrary value of any stock doesn’t tell you anything about the value of the underlying company. Saudi Aramco at $7 a share is not “cheaper” than Meta at $700 a share, despite both companies being about the same size. Whether a stock is “cheap” can be analyzed through the lens of a valuation ratio, the most common being a “price to earnings” or P/E ratio. Since we predominantly discuss disruptive tech companies that have not achieved positive earnings, we mostly use simple valuation ratio (SVR) which is market cap divided by annualized revenues. An SVR is an indicator of how much revenue your business generates relative to its value.

One problem with using SVR is that not all revenues are created the same. The cost to produce revenues – called cost of goods sold or COGS – can differ across businesses and industries which means some companies have much greater potential for profits than others. Gross margin gives us an indicator of just how profitable a business can possibly be. Anything above 80% is great, so Arm managing a gross margin of 96% is nothing short of spectacular. They should be practically printing money.

Arm’s Incredible Business Model

Developing chip designs, licensing them to partners, then collecting downstream royalties is how you manage to achieve gross margins in the mid-90s. Arm seems to have the Holy Grail of fabless semiconductor business models which customers