Serious Concerns Growing About ARM’s Growth Engine Valuation

Wednesday’s downgrade was from UBS A.G. (NYSE: UBS), where the rating went to Neutral from Buy. The firm cited peak multiples of earnings, or in other words, it was a valuation downgrade. UBS actually did raise its target to 900p in the U.K. from 750p, but that implies less than 10% upside with an 840p price in London. UBS also raised earnings expectations based on higher royalties in the next four years, but a valuation peak call is what it is.

Tuesday’s downgrade was from Morgan Stanley (NYSE: MS), with a downgrade to Equal Weight from Overweight. This price target was also lifted to just over 900p from 725p, but the firm said that it is unattractive for new money investment at about 44-times earnings.

Monday’s downgrade came from Piper Jaffray, with that downgrade going to Neutral from Overweight. Its price target in dollar terms is $40.00 for this ADR.

None of these analyst have said that anything is wrong with ARM other than it is fully valued. The ADR still trades above $40 in New York, and the consensus dollar-adjusted price target from Thomson Reuters is about $36.50 per share.

With this ADR still just above $40.00 as of now, the 52-week trading range is $21.64 to $42.55 and the market capitalization rate is $18.5 billion. As far as its ADRs, ARM Holdings trades at 57-times 2012 earnings and almost 46-times 2013 earnings estimates.

If you want to know what has driven ARM’s share price, it is the mobile Web you hold in your hand. ARM licenses its technology to semiconductor and OEM partners for a royalty payment stream. The company said that in 2011 its partners shipped nearly 8 billion ARM-powered chips. Its design is said to be used in more than 95% of the world’s mobile phones, and it is being used more and more in many of the tablets as well. ARM also said that its technology is being increasingly used in digital TVs, hard disk drives, washing machines and other applications.

Can ARM keep beating expectations and surging forward for investors? Sure. The investment community just has to know by now that valuations are excessive and the bar will be set higher and higher each quarter ahead.