The Arm IPO and Tech Stocks Are on Fire. Consider This ETF.

The company’s prospects revealed sales of about $2.7 billion in fiscal 2023, down a bit year over year on the back of a weak smartphone market. Analysts who cover
Apple
(AAPL) expect smartphone growth in 2024 in the low-single-digit percentages as consumer demand stabilizes and an upgrade cycle kicks in. That could bring Arm’s sales to somewhere close to $3 billion. But the company likely won’t see rapid sales growth for the long term, given that smartphone components represent the majority of the company’s sales.

Now, Arm’s multiple is way higher than the 2.4 times sales for the
S&P 500,
which analysts expect 5% sales growth for in 2024, not so different than the usual for Arm.

This valuation exuberance is even leading Instacart to lift its targeted offering price, as the company sees that investors are probably willing to pay a high price. The company is now eyeing a level that reflects a $9.9 billion market value, up from $9.3 billion, previously.

The rising values are part of a market that’s been increasingly willing to pay up for tech companies. The
Nasdaq 100
is up more than 40% this year, and now trades at about 24.5 times expected earnings per share for the next 12 months, up from about 20.9 times in January. 

Driving that multiple, in part, is the advent of artificial-intelligence advancements, which has boosted profit growth estimates. That is pushing more money into these IPOs—making them more expensive—since so many Nasdaq 100 stocks have already risen on the back of AI trends. Basically, investors looking for growth opportunities outside of the Nasdaq 100 are clamoring for anything else they can find. Arm mentioned the use of AI in its prospectus, but that doesn’t mean it’s going to grow as rapidly as the leaders in AI technology such as
Nvidia
(NVDA).

This is why non-tech stocks, or the rest of the market, look more attractive. 

The
Invesco S&P 500 Equal Weight
exchange-traded fund (RSP), which weights each stock in the index equally and therefore gives investors true exposure to a the diversification of all 500 stocks, is an interesting option for investors to consider.

The ETF has already underperformed a lot recently, something that should reverse. It is up about 5% this year, versus the conventional S&P 500’s 17% gain, driven by tech names. The share price of the equal-weighted ETF as a percentage of the S&P 500’s price is almost as low as it gets in the past four years, according to Morgan Stanley, suggesting better gains from here are a strong possibility.

Consistent with that, the RSP is cheap, trading at about 14.9 times earnings-per-share estimates. That’s a 21% discount to the S&P 500’s 18.9 times, according to FactSet. It traded much closer to the S&P 500—at just a 12% discount—in November 2022 when tech stocks were out of favor.  

That could set the stage for earnings growth to take the ETF higher. Analysts expect aggregate sales for it to grow in the low single digits annually for the next two years, according to FactSet. As rate hikes go on pause, it will ease the pressure on economic demand, and enable positive year-over-year revenue comparisons. That should help profit margins inch higher, especially as cost increases such as wage gains, moderate. That should translate into about 11% annualized earnings-per-share growth over the next two years to about $11.55 by 2025. 

That should provide pretty solid gains. 

Write to Jacob Sonenshine at [email protected]