Is Arm Holdings (ARM) Overvalued Despite Its Expanding AI and IoT Influence?

The question of whether Arm Holdings (ARM) is overvalued has become a focal point for investors navigating the high-stakes semiconductor sector. With a trailing price-to-earnings (P/E) ratio of 148.31 as of January 2026- a sharp decline from its 2024 peak of 423- the stock remains significantly above the semiconductor industry average of 36.7x. Meanwhile, Arm's price-to-book (P/B) ratio of 20.12 dwarfs the industry's 2.82, raising concerns about whether its valuation is justified by fundamentals. This analysis examines Arm's structural growth tailwinds in AI and IoT, its competitive positioning, and the risks that could undermine its lofty multiples.

Structural Growth Tailwinds: AI and IoT as Catalysts

Arm's recent financial performance underscores its pivotal role in the AI and IoT revolutions. For Q2 2026, the company reported revenue of $1.14 billion, a 34% year-over-year increase, driven by its Armv9 architecture and Neoverse platform. These technologies are now powering nearly 50% of new hyperscaler CPU installations in data centers, with major clients like Amazon, Google, and Microsoft expanding their use of Arm-based processors for AI workloads. The company has shipped over 1 billion Neoverse CPU cores, and strategic partnerships-such as Google's migration of 30,000 cloud applications-highlight its growing influence in the AI infrastructure market.

In the IoT and edge computing space, Arm's ecosystem of 22 million developers and platforms like Lumex CSS are enabling on-device AI capabilities, further diversifying its revenue streams. Analysts project that this momentum will continue into 2026, with third-quarter revenue forecasts reaching $1.23 billion. Such growth is underpinned by Arm's 99% market share in mobile chip design and its ability to monetize high-margin IP licensing, with gross margins exceeding 95%.

Competitive Threats and Valuation Risks

Despite these tailwinds, Arm's valuation faces scrutiny. Its P/E ratio of 144.8x is nearly four times that of NVIDIA (33.46x) and Qualcomm (14.12x), two peers with more predictable cash flows. Morningstar's fair value estimate of $57 suggests the stock is overvalued by 105% relative to its December 2025 price of $115.68. This disconnect may reflect investor skepticism about Arm's ability to sustain its growth.

Key risks include rising R&D and operating expenses as the company invests in custom chip development, which could pressure near-term profitability. Additionally, Arm's dominance in China-a market critical to its growth-is being challenged by RISC-V, an open-source architecture backed by the Chinese government. This threat could erode royalty revenue, particularly as RISC-V gains traction in low-cost IoT and embedded applications.

Another concern is Arm's potential shift into CPU manufacturing, which could alienate partners like Apple and Qualcomm. Such a move would transform Arm from an IP licensor into a direct competitor, risking long-term ecosystem stability. Meanwhile, the stock's 20.33% decline over the past year-contrasting with a 38% industry gain-suggests market doubts about its execution risks.

Balancing Growth and Valuation

Arm's valuation appears stretched relative to peers, but its structural growth in AI and IoT could justify the premium. The company's 29.83% annualized earnings growth forecast and 47% year-over-year revenue increase in Q4 2024 demonstrate its ability to capitalize on secular trends. However, investors must weigh these positives against execution risks, including RISC-V competition, rising costs, and potential partner conflicts.

For long-term investors, Arm's position as a foundational player in AI infrastructure and IoT could offer asymmetric upside. Yet, for those prioritizing near-term returns, the stock's high multiples and operational uncertainties may warrant caution. As the semiconductor sector evolves, Arm's ability to maintain its IP licensing model while navigating disruptive technologies will be critical to its valuation trajectory.