Why Arm's stock just got a downgrade after its big rally

By Emily Bary

HSBC sees Arm shares trading at a premium to peers after they more than doubled on the year through Friday's close

Arm Holdings PLC has a "great narrative," but that may not be enough to further power its stock.

In fact, shares could head lower from here, according to HSBC analyst Frank Lee, who downgraded them to reduce from hold on Monday. His new price target of $105, up slightly from $100, was still about 30% below where shares closed on Friday.

Arm's stock (ARM) is down more than 4% in midday trading Monday.

"We believe Arm has one of the best narratives among our tech coverage given expectations of significant content growth from rising royalties for its smartphones and future [artificial-intelligence] markets such as AI PC and [data-center central processing units]," Lee wrote.

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But Arm shares had also more than doubled on the year as of when Lee published his report, such that they were trading at 72 times estimated earnings for the company's 2026 fiscal year, which ends in March. That puts Arm's stock at "a significant premium relative to its large-cap semiconductor peers," Lee wrote.

Meanwhile, Arm is due to report fiscal first-quarter results on Wednesday, and Lee cited the prospect of "short-term earnings downside risk given a potential slowdown in Android smartphone momentum and a less bullish AI narrative than previously expected."

Despite general optimism about the potential for AI-enabled personal computers, Lee wonders if adoption will prove less robust than some hope. He flagged his "bullish view on royalty payments per chip for AI PC [central processing units]" but also noted "mixed feedback" over the performance of Qualcomm Inc.-powered offerings after their debut.

Further, he expanded upon the possibility that pressures in the smartphone market extend into the September quarter. For example, Android handsets in China could see a 15% sequential decline, he wrote. That could weigh on Arm's results for that period.

Lee noted that one risk to his view is Arm's ownership structure, through which only about 10% of shares are freely floated. Downside is "protected by limited liquidity," he wrote.

Following the HSBC downgrade, four of the 35 analysts tracked by FactSet who cover Arm's stock rate it the equivalent of sell. Seventeen have buy-grade ratings and 14 are at the equivalent of neutral.

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-Emily Bary

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07-29-24 1233ET

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