The ongoing adoption of artificial intelligence (AI) has been a boon to a number of companies, including Arm Holdings (ARM -5.85%). The stock is currently taking a breather, but it's still up 69% over the past year, as of the market close on Wednesday. The sudden reversal has some investors concerned that its rally has stalled.

That's simply not the case, according to one Wall Street analyst, who suggests there are several catalysts that will send the stock higher over the coming year or so.

Riding the wave of AI

Evercore ISI Group analyst Mark Lipacis initiated coverage on Arm stock with an outperform (buy) rating, while simultaneously assigning a price target of $156. This represents a potential upside of 45%, compared to the stock's closing price on Wednesday. The analyst cites three "tectonic" shifts taking place in computing that will benefit Arm, all largely thanks to the advent of generative AI:

  • AI will require greater on-device processing for smartphones.
  • Data centers are shifting away from traditional x86 central processing units (CPUs) to more robust processors to handle the demands of AI.
  • The expansion of AI capabilities, particularly into the Internet of Things, could experience a tenfold increase in demand.

It's clear the analyst has done his homework. Arm profits from the use of its chip designs by third parties and has experienced a boom in recent months as the expansion of AI accelerates. As a result of the increased demand, Arm generated record revenue that grew 14% year over year in its fiscal 2024 third quarter (ended Dec. 31), fueled by record royalty revenue for its processor designs. At the same time, earnings per share jumped 32%.

More telling, however, was the company's remaining performance obligation (RPO), which includes contractually obligated sales that haven't yet been included in revenue. This increased by 38%, which shows that Arm's growth is accelerating.

When measured in terms of Arm's forward price/earnings-to-growth (PEG) ratio, its valuation is less than 1, the standard for an undervalued stock. That's why Arm stock is a buy.