The oddities in the market continue to rise with each passing day. The longer a trend remains in place, the more people will inevitably conclude that this is the state of things forever. Rather than just do the usual critique of the “bubble du jour”, we will actually give you a great way to feed your FOMO right now, without paying the proverbial arm and a leg. Let’s dig into Arm Holdings (NASDAQ:ARM) and see why this exponentially rising stock is due for at least a 50% drop, but you can come out ahead, even if you are bullish!
Q3-FY-2024
ARM’s fiscal year end is in March so the recently released quarterly results were for the third quarter of the current fiscal year. On the first slide we saw what appeared to be blowout results.
Well you would think that was the case, considering the stock gapped up from around $78, and traded as high as $130. But were the results really that special? Revenue growth was modest, especially for such a hyped stock. ARM reported amazing non-GAAP gross margins, but that is the nature of the royalty business. Further down operating costs were quite high and cash conversion was not exactly stellar.
While the revenue trends were hailed as amazing, you can gauge for yourself if that looks spectacular or not.
Operating profit is also not expanding at a rapid clip and has been all over the place.
Through all of this ARM has managed to amass a $150 billion market cap.
What is truly impressive here that this slow growing company has a price to sales ratio, higher than even the sector leader.
So what’s driving this?
Well it could be the new Arm V9 architecture. This upgraded version carries a higher royalty rate (approximately double) the previous one. V9 adoption is gradually increasing in smartphones and briskly increasing in data centers. So ARM should benefit from more volume over time and higher royalty rates on that volume. That story is well known though. Revenue estimates for ARM are incorporating this and while there may be a few “beats” in the future, it will be difficult for ARM to materially breach these numbers.
Alongside that, we have the company trading 64X non-GAAP estimates for 2027.
Non-GAAP. We want to stress that. Because if you look at GAAP numbers they look really bad. The company made $0.08 a share.
While it reported $0.29 a share in the Non-GAAP category.
ARM’s GAAP to Non-GAAP numbers are a total delight if you are into investigating what shareholder’s profits actually are in all of this.
The key difference is the equity awards/stock options.
Total share-based compensation cost, including both cash and equity settled awards, was $199 million for the three months ended December 31, 2023.
Source: ARM Holdings
Hey 75% of shareholder money went towards equity awards settlement, but who cares, right? AI, AI, AI. This number will go even higher in the months ahead, but let us focus on Non-GAAP
How To Deal With Your FOMO
We are directing this at investors who bought into ARM, either at the IPO or shortly after and are sitting on fat gains. In the back of their mind though, they hear the familiar, “should have bought more”. If you do have the shares and the FOMO, we do have a prescription for you. It involves using the extraordinarily high volatility in these shares and it requires recognizing that whenever this bubble pops, a 50% drop will be the baseline minimum. It also requires knowing that the current price is the result of the extraordinarily short float, and the lockup expiration coming on March 14, 2024. If all of this fits, here is the trade for those who own the shares. On the existing shares, you sell a $170.00 Call at $67.20 for June 18, 2026. In addition you sell 1 Cash Secured Put for $130.00 strike at $49.30, also for June 18, 2026.
So how does that work out?
Assuming trees do grow to the sky, and ARM keeps going up and up and stays up, all the way through the next 34 months, you will sell your existing shares. The price you get, pretty fantastic. You get $170.00 (Call strike)+ $67.20 (call premium) + $49.30 (CSP premium). That works out to $286.50. Even if you use the high estimates for 2026, you are selling at 118X those non-GAAP earnings.
An acceptable outcome to say the least. But what about your FOMO? Well with this method you are also offering to buy shares, but at a ridiculous price. If the stock tanks and closes anywhere below $130.00 by June 18, 2026, you do get long an additional 100 shares. But those shares are given to you at a stupidly low price. Your net cost basis on those shares would be:
$130.00 (exercised put shares) – $67.20 (call premium) – $49.30 (CSP premium) = $13.50. That’s right, you own 100 more shares at a cost basis of $13.50.
Verdict
The extraordinarily high option premiums allow you to feed your FOMO and also feed the “ducks”. By ducks we mean the ones chasing this at 400X GAAP earnings. ARM is a pure bubble but of course at $13.50 even we would be interested in buying some. Use the combined premiums to set up a great entry or a great exit.
Please note that this is not financial advice. It may seem like it, sound like it, but surprisingly, it is not. Investors are expected to do their own due diligence and consult with a professional who knows their objectives and constraints.