There has been a great deal of hype over the past year or so about the impact of artificial intelligence (AI). The consensus is that these latest developments are groundbreaking and will increase human productivity many times over by automating an increasing number of time-consuming tasks. As companies scramble to capitalize on these developments, some fear that the market has entered an AI bubble.
Holding arm (arm 0.41%) CEO Rene Haas leaves no doubt which camp he belongs to. He believed that “artificial intelligence is in no way a hype cycle.” “We believe that AI is the most profound opportunity of our lives, and we are only at the beginning.”
Although it may seem like an exaggeration, many in technology circles hold this view. Estimates run the gamut, but the potential economic impact could be enormous. Generative AI is estimated to be worth between $2.6 trillion and $4.4 trillion annually, according to global management consulting firm McKinsey & Company. Companies on the bleeding edge of these secular tailwinds may end up reaping a real windfall.
It is no coincidence that Arm Holdings is one of these companies and has positioned itself to benefit from the AI revolution.
Image source: Getty Images.
Extensive library of intellectual property
To understand Arm's place in the broader AI ecosystem, it helps to know a little about the company's strategy. Arm Holdings was founded in 1990 with the goal of changing the computing industry. After the product failed in 1993, the company changed its business model. Arm began developing and licensing chips Designs Rather than the chips themselves, their pivot to intellectual property is complete.
Over the next two decades, ARM became a force in the semiconductor industry, creating and licensing the blueprints for some of the world's most widely used chips. The company's expertise can be found in a range of devices, including smartphones, tablets, PCs and smart TVs. In fact, Arm estimates that its processors are used by 70% of the world's population. The key here is that their AI-centric designs are prolific in cloud computing, hyperscale computing, and data centers.
Because Arm designs and licenses its own processor designs, it achieves significant economies of scale and can do so at a much lower cost than most companies could achieve on their own.
The vast opportunity of artificial intelligence
if Nvidia He is the king of AI, and Arm Holdings is arguably the queen.
Nvidia graphics processing units (GPUs) are the gold standard for training and running AI models. What does this have to do with ARM? The company's cutting-edge central processing units (CPUs) play a key role in AI processing. For example, Nvidia's GH200 Grace Hopper Superchip — which fuses accelerated CPU and GPU technology to meet the computational demands of AI — uses 144 Arm version 9 (V9) CPU cores.
Nvidia isn't just relying on the latest Arm processors. MicrosoftThe new AI-based server chips have more than 100 of them. In a recent interview, Haas noted that many customers are switching to the V9 engine. Not only does this core offer more processing power, but it comes with twice the royalty rate of its predecessor – which will be a boon for Arm.
Secular AI tailwinds are starting to show in ARM's results. For the company's third quarter of fiscal year 2024 (ending December 31, 2023), the register Revenue grew 14% year-over-year to $824 million, helped by licensing revenue that jumped 18%. register Royalty income increased by 11%. This resulted in adjusted earnings per share (EPS) of $0.29, an increase of 32%. But this only tells part of the story.
Arm's remaining performance obligation (RPO) — or contractually obligated sales not yet reflected in revenue — rose to $2.43 billion, up 38% year over year. This suggests that its revenue growth is likely to continue to accelerate.
Management's forecasts appear to support this assertion. In Q4, Arm forecasts revenue of $850 million to $900 million, representing growth between 34% and 42% – More than double 14% growth in the third quarter
To kick off the GPU Technology Conference (GTC) last week, Nvidia debuted its long-awaited Blackwell architecture, which takes AI processing to the next level. The superior Blackwell GB200 chip houses two B200 GPUs and an Arm-based Grace CPU. While specific details are still sparse, this will undoubtedly cement Arm's place in the AI revolution.
For investors who rely on the most common valuation metrics, Arm can be a tough sell. The stock currently trades for 109 times forward earnings and 34 times next year's sales. However, these metrics don't take into account Arm's significant growth trajectory. The price-to-earnings-to-growth (PEG) ratio – which influences this growth – is less than 1, which is the standard for undervalued stocks.
Given Arm's decades of experience, ubiquitous chip blueprints, and accelerating demand for artificial intelligence, Arm could represent a once-in-a-generation investment opportunity.
Danny Fina holds positions at Microsoft and Nvidia. The Motley Fool has positions in and recommends Microsoft and Nvidia. The Motley Fool recommends the following options: long $395 January 2026 calls on Microsoft and short $405 January 2026 calls on Microsoft. The Motley Fool has a disclosure policy.
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