Nvidia’s shares have surged 750% since ChatGPT launched in November 2022, making it a foundational AI stock in many portfolios. However, with a market capitalization of just shy of $3 trillion, the odds of similar returns in the future are slim.
Some investors have shifted focus to Arm Holdings (ARM), hoping to find the “next Nvidia.” Arm’s stock has more than doubled since the company went public in September 2023, and Morgan Stanley believes the momentum could continue. The bull-case price target of $300 per share implies a 130% upside from its current share price of $129.
Arm designs central processing unit (CPU) architectures and licenses the intellectual property (IP) to other companies, which use the IP to build custom chips. The company earns revenue via licensing fees and pre-chip royalty fees. Arm has an attractive business model, gaining share in key markets like cloud computing and consumer electronics.
Arm’s dominance in mobile devices means the company should benefit as more AI workloads run on edge devices. Morgan Stanley believes Arm is particularly well-positioned to monetize edge AI, where data is processed at the device level rather than sent back to centralized data centers.
CEO Rene Haas recently told Reuters that Arm could capture more than 50% market share in Windows PCs within five years. This would represent a significant shake-up for the PC industry.
Arm stock trades at an expensive valuation, compared to its future growth trajectory. Wall Street expects Arm to grow adjusted earnings at 29% annually through fiscal 2027. Morgan Stanley has outlined base-case and bull-case scenarios in which earnings grow at 46% annually and 69% annually, respectively.
However, I doubt Arm’s earnings will increase much faster than the Wall Street consensus in the coming years. The company guidance implies 22% earnings growth in fiscal 2025, which actually falls short of the consensus. Moreover, that projection makes the current valuation of 94 times adjusted earnings look expensive.
In summary, Arm has an attractive business model and is gaining share in key markets. While it’s well-positioned to monetize edge AI, I doubt the stock will deliver triple-digit returns over the next year.
Source: https://www.fool.com/investing/2024/08/02/ai-stock-next-nvidia-could-surge-130-wall-street/