Artificial intelligence (AI) stocks are on fire these days.
We haven't even made it to Valentine's Day, and already superstar AI chipmaker Nvidia (NASDAQ: NVDA) is up 46% this year, while Super Micro Computer, a maker of server and storage equipment used for AI models, has jumped 161%, and even Taiwan Semiconductor Manufacturing, the world's largest contract chip manufacturer, is up 28% this year.
The AI boom promises to deliver plenty more winners, and one AI stock, in particular, looks like a great buy right now.
Image source: Getty Images.
Arm: Winning the AI CPU market
Arm Holdings (ARM 4.11%) went public last year, but the CPU architecture specialist officially crashed the AI party last week as the stock jumped 48% on the company's third-quarter earnings report.
Arm's numbers were strong, but what really impressed the market were the signs that the company is emerging as a key player in the AI revolution.
The semiconductor company has a unique model, bringing in revenue from licensing and royalties. It licenses its central processing unit (CPU) design to other chipmakers like Nvidia and cloud-infrastructure hyperscalers like Amazon, Microsoft, and Alphabet. It also collects money from royalties when those chips containing its CPUs are sold or deployed, giving it a valuable, high-margin business model with recurring revenue.
During the third quarter, license revenue jumped 18% to $354 million, ahead of expectations as management said, "More companies ... [are] choosing Arm's most advanced CPUs to run AI, where more advanced CPUs command a higher license fee." Those licenses will also continue to pay off in the form of increased royalties in the future.
Arm has a competitive advantage in the CPU market that is giving it an edge over rivals like Advanced Micro Devices and Intel. Its CPU architecture is valued for its extremely power-efficient architecture. Its chips were originally made to run batteries, which need to conserve power, and it's been developing that technology for 30 years.
That's a big reason why Arm's CPUs are found in 99% of the world's smartphones, where extending battery life and conserving power comes at a premium.
Tasks like powering data centers and running the large language models that make programs like ChatGPT also benefit from efficient architecture, which means that Arm's chips are in demand for AI applications. As CFO Jason Child explained in an interview with The Motley Fool, "These AI workloads are so power intensive, they needed to go figure out how to create a much, much lower cost solution versus what they could buy off the shelf at AMD or Intel."
Nvidia's key partner
Arm also has another valuable advantage in the AI race. It's a close partner of Nvidia. CEO Rene Haas previously worked at Nvidia under Jensen Huang, Nvidia's chief, and Nvidia and Arm had an acquisition deal in 2020 before the Federal Trade Commission blocked it, leading to Arm's initial public offering last year.
Two years ago, when Nvidia backed off from the acquisition, Huang said:
"Arm has a bright future, and we'll continue to support them as a proud licensee for decades to come. Arm is at the center of the important dynamics in computing. Though we won't be one company, we will partner closely with Arm."
That prediction is becoming a reality. Arm's technology is at the heart of the new Grace Hopper H200 Superchip, the next iteration of the H100 accelerator that's been in extraordinarily high demand since OpenAI launched ChatGPT. The platform contains 144 Arm Neoverse cores, Arm's state-of-the-art CPU designed for applications like high-performance computing and machine learning.
Arm was not involved in the H100, but its presence in the H200 is likely to lead to a large royalty stream, given Nvidia's dominance of AI. Additionally, Nvidia tapped Arm last October for its new AI PC chips in a bold challenge to Intel's core market.
Why the future is bright for Arm
It's no accident that Arm jumped 50% on its earnings report, nor is it a mistake that Nvidia shares are up nearly 50% year to date after more than tripling last year. It's becoming increasingly clear that generative AI will be the next major computing platform, and the competitive advantages lie with hardware companies like Arm and Nvidia, at least until the voracious demand for AI compute slows down -- and there's no sign of that happening anytime soon.
Arm's unique business model also gives it an edge as it will cash in on royalties as it sells more licenses for its valuable CPUs. As the AI market expands, Arm will grow along with it.
