Arm Holdings has firmly established itself as one of the hottest artificial intelligence (AI) stocks in the U.S. market. The success it has enjoyed since going public last year at a substantial valuation raises questions about the extent of its potential.
In early Friday trading, Arm's shares, which had surged by an impressive 48% on Thursday following an outstanding earnings report, were down 3.1% to $110.38. Despite this dip, it seems poised to retain the majority of the gains made.
Before Arm's initial public offering (IPO) at $51 a share in September, skepticism surrounded the British company's potential benefits from AI spending. The focus on licensing designs for central processing units (CPUs) and heavy reliance on the smartphone market seemed incongruent with the early emphasis on graphics processing units for data centers, as championed by Nvidia and others. However, this narrative has evolved, with premium smartphones now integrating AI capabilities that demand Arm's latest chip designs, leading to increased royalty rates. Arm is also expanding its presence in other sectors like cloud servers and the automotive industry.
J.P. Morgan analyst Harlan Sur expressed optimism, stating, "We believe that as AI proliferates across multiple end markets there is a growing requirement for more compute power/intellectual property and [that] benefits Arm." Sur raised his target price on Arm to $100 from $70, maintaining an Overweight rating. The average analyst target price on Wall Street is $91.49.
However, further gains for Arm may hinge on the extent to which its chip designs are licensed for AI applications beyond smartphones. Reports have suggested that Nvidia and Advanced Micro Devices are developing their own Arm-based processors for Windows PCs, potentially shipping in 2025.
Despite the positive outlook, there are significant caveats. Arm is still over 90% owned by Japan's SoftBank Group, which provides some support to the price but also means that moves can be exaggerated due to the limited number of shares available for trading. Arm's trading volume on Thursday was 106.5 million, compared to a public float of just over one billion shares and a 65-day average trading volume of 8.4 million shares.
The IPO lockup period, preventing company insiders from selling the stock, is set to expire on March 12. Arm's valuation is noteworthy, trading at a trailing price-to-earnings ratio of 223 times, according to FactSet. Looking ahead, when considering the price-to-earnings ratio, it's trading at approximately 79 times the earnings. While Nvidia has demonstrated how such multiples can compress quickly, it still sets a high bar for Arm. The road ahead for Arm appears promising, but potential challenges and uncertainties loom large.
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