Investors have been buying semiconductor stocks hand over fist in recent months as this sector is primed to benefit big time from the proliferation of artificial intelligence (AI), which is not surprising as semiconductors are enabling tech giants to train AI models of all sizes.
Nvidia has been an early winner in this market. The computing power of its graphics processing units (GPUs) has been harnessed by multiple companies to train large language models (LLMs), including ChatGPT. As a result, shares of Nvidia have simply taken off over the past year on the back of eye-popping growth in the company's revenue and earnings.
However, there is another company that's playing a central role in the AI chip market -- Arm Holdings (ARM 4.11%). Assuming you have $1,000 in investible cash right now after paying your bills, clearing high-interest debt, and saving for difficult times, it may be a good idea to put that money into Arm. Let's look at the reasons why.
Arm could win big from the growing demand for AI chips
Arm doesn't manufacture any chips of its own. The British company licenses its chip designs and architecture to semiconductor companies and device manufacturers, who then use Arm's intellectual property to make processors and components used in electronic devices such as smartphones and computers.
Arm receives a licensing fee from those who use its intellectual property. It also receives a royalty from customers for each chip they sell containing Arm's design. So, the following statement from CEO Rene Haas on the company's latest earnings call didn't come across as a surprise:
From the most complex devices on the planet for training and inference, the Nvidia Grace Hopper 200, to edge devices such as the Gemini Nano Pixel 6 from Google or the Samsung Galaxy S24, more and more AI is running on more end devices, and that's all running on Arm. And what that has done is driven a very strong set of tailwinds for our licensing growth.
This is precisely the reason why Arm is in a solid position to capitalize on the growing demand for AI chips, and its latest results tell us the same.
Shares of Arm shot up a whopping 48% in a single day after the company released its fiscal 2024 third-quarter results (for the three months ended Dec. 31, 2023) on Feb. 7. This massive surge in Arm stock was driven by the company's forecast for the current quarter, which points toward a significant jump in growth.
More specifically, Arm delivered record fiscal Q3 revenue of $824 million, an increase of 14% from the prior year. What's more, Arm's revenue easily exceeded the company's original guidance range of $720 million to $800 million. The stronger growth was driven by a nice jump in Arm's licensing revenue thanks to the growing demand for high-performance central processing units (CPUs) to enable AI functionality across different devices.
Last quarter, the company signed five new Arm Total Access (ATA) licensing agreements for AI-specific chips. ATA agreements help licensees accelerate their chip development programs and reduce the time-to-market for new chips as they provide "the most comprehensive package of IP products, tools and models, support and training, software and physical design in an easy-to-access subscription."
Even better, CFO Jason Child remarked on the latest earnings conference call:
Additionally, we are expecting another strong quarter for licensing with revenue up sequentially to near-record levels. As with recent quarters, we expect to sign multiple new ATA deals in Q4, and demand for our latest technology remains high as customers need access to AI-capable CPUs and related technology, such as our compute subsystems.
It is worth noting that Arm's latest chip architecture -- the Armv9 -- was announced in 2021 to enhance the AI capabilities of chips. Not surprisingly, the company is witnessing an improvement in the adoption of Armv9. The company says that 15% of its royalty revenue was produced by this architecture in the previous quarter, up from 10% in the previous one.
Looking ahead, the Armv9 could drive stronger royalty revenue growth for the company as it "garners roughly 2x the royalty rate of the equivalent v8 product." As such, Arm seems well-placed to grow both its licensing and royalty revenue as the need for more advanced AI chips arises. This also explains why the company has issued a solid outlook for the current quarter and the full year.
Investors can expect tremendous gains thanks to a sharp acceleration in growth
Arm predicts fiscal Q4 revenue to land at $875 million at the midpoint of its guidance range, while non-GAAP earnings are estimated at $0.30 per share. The top-line forecast points toward an impressive 38% year-over-year increase, which would be a significant bump as compared to the previous quarter. Analysts would have settled for $0.21 per share in earnings on $780 million, but the AI-fueled growth at Arm helped it crush those estimates.
The company is now expecting fiscal 2024 revenue to land at $3.18 billion as compared to the prior expectation of $3.02 billion. It has increased its full-year earnings guidance to $1.22 per share from $1.05 per share. The updated revenue guidance for fiscal 2024 points toward annual growth of almost 19%. More importantly, analysts have raised their expectations and expect Arm's robust top and bottom-line growth to continue over the next couple of years.
ARM Revenue Estimates for Next Fiscal Year data by YCharts
Additionally, analysts are forecasting Arm's earnings to increase at an annual rate of 41% for the next five years. Based on its fiscal 2024 earnings estimate of $1.22 per share, its bottom line could jump to $6.80 per share after five years. Using the Nasdaq-100 index's forward earnings multiple of 30 as a proxy for tech stocks, Arm's stock price could jump to $204 in five years, a potential upside of 77% from current levels.
Of course, the stock is currently trading at an expensive 82 times forward earnings, but it could justify the same thanks to the AI-driven growth that it is expected to deliver. So, if you have $1,000 to invest right now, buying Arm could turn out to be a smart move, as this AI stock may turn that money into more than $1,700 over the next five years.
