Contemplate if you consider Think Arm Holdings Overpriced? The Artificial Intelligence (AI) Shares Carry an Unexpected Strategy Within.
Contemplate if you consider Think Arm Holdings Overpriced? The Artificial Intelligence (AI) Shares Carry an Unexpected Strategy Within.
ARM Holdings (ARM 0.04%) has emerged as one of the significant victors in the artificial intelligence (AI) revolution. Entering the scene somewhat late, it went public in September 2023, nearly a year after ChatGPT's debut, yet its stock has tripled from its initial public offering (IPO) price.
ARM is a semiconductor company, primarily earning income through the licensing of chip designs, primarily for CPUs, to entities like Nvidia. Once these chips are sold, ARM accumulates royalties. Due to its involvement in the AI boom, it's perceived as an AI stock and is valued accordingly, like its AI-centric counterparts. Post its second-quarter earnings report, the stock trades at a price-to-sales ratio of 45 and a price-to-earnings ratio of 109.
This valuation has prompted some doubt, and there appears to be confusion regarding its business model. The stock dipped in after-hours trading following the earnings report before regaining ground during regular trading.
In the reporting quarter, ARM's revenue increased by a modest 5% to $844 million, as it surpassed a substantial licensing deal from the preceding quarter. Despite a 15% decrease in licensing revenue, royalty revenue rose by 23%. However, ARM's business model means that a large portion of its future growth is already secured, as it continues to collect royalties on technology it has already licensed.
Do not undervalue ARM stock
ARM's primary market is the smartphone sector, where it holds a significant share of the CPU market. Its chips are present in more than 99% of smartphones, and its power-conserving architecture outperforms the X86 technology from Intel and Advanced Micro Devices.
Approximately 40% of its revenue is derived from the smartphone market, and the smartphone industry has generally stabilized, as indicated by Apple's financial performance. Despite the smartphone market growing by just 4% in the quarter, according to IDC data, ARM reported a 40% increase in royalty revenue from smartphones, demonstrating its ability to expand in a seemingly mature market.
This achievement was due in part to its advanced Armv9 technology, which carries a twice-as-high royalty rate compared to the previous-generation Armv8. Furthermore, as per ARM CFO Jason Child in an interview with Our Website, the price of the chips on which ARM collects royalties has increased as well, stating, "In smartphones, a flagship chip cost $75 10 years ago, but a Snapdragon [from Qualcomm] now costs $200."
With both the royalty rate and chip pricing on the rise, it becomes apparent why ARM can grow revenue even in a stagnant smartphone market. For instance, a 3% royalty on a $75 chip would yield $2.25, while a 5% royalty on a $200 chip would be $10, more than triple the initial figure.
Further growth potential
ARM harbors considerable opportunity in the data center market, but Child anticipates the smartphone market to continue being its principal segment in the near future.
Nevertheless, its growth rate should accelerate in the second half of its fiscal year due to the release of Microsoft's Arm-based Cobalt data center chips on its cloud infrastructure platform, as well as Alphabet's unveiling of its new Arm-based Axion data center chip.
Both of these chips are expected to drive stronger growth for the company in the second half of the fiscal year, as will the adoption of its compute subsystems (CSS), which offer packaging along with the CPU design and carry an even higher royalty rate than v9.
Thanks to its power-efficient CPU architecture, ARM should maintain substantial operating margins and be able to grow even in slow-growth markets by virtue of higher royalty rates from newer technology and increasing chip prices.
Although the stock may appear expensive, it continues to hold a promising position for long-term success.
Despite the high price-to-sales and price-to-earnings ratios, investing in ARM Holdings could be a smart financial decision due to its dominance in the smartphone market and potential growth in the data center sector. The company's advanced Armv9 technology, high royalty rates, and increasing chip prices provide a solid foundation for future revenue growth, even in mature markets.