With shares up by a whopping 37% year to date, Arm Holdings (ARM -3.43%) is one of many technology companies that have received significant attention because of their potential in artificial intelligence (AI). But unlike alternatives like Nvidia, the hype surrounding Arm Holdings hasn't materialized into significant business growth. Let's dig deeper into what the next five years could have in store for the company.

Why is Arm Holdings so popular?

Since its initial public offering (IPO) in September 2023, Arm Holdings has become a Wall Street darling. The U.K.-based technology company designs and licenses high-performance, energy-efficient designs for central processing units (CPUs) -- a type of semiconductor chip that enables computers to run their operating system and applications.

While Arm doesn't sell chips directly, some investors are optimistic that AI-related demand could boost its business. But so far, the numbers aren't impressive. Fiscal third-quarter revenue increased by only 14% year over year to $824 million, while net income halved to $87 million. To make matters worse, Arm's management states that this modest growth was mainly because of a recovery in the smartphone market, which has nothing to do with AI.

To put Arm's growth in perspective against a "real" AI company, Nvidia's top line grew 265% year over year (to $22.1 billion) in its most recent quarter while its profits skyrocketed 769%.

What could the next five years have in store for Arm Holdings?

Right now, many companies seem to be overstating their potential in AI to earn a greater valuation for their investors. But over the next five years, these companies must translate this hype into sustainable earnings and cash flow to justify their stock price gains. Arm's CEO, Rene Haas, seems confident that his company is up to the task.

Arm's CPU architecture is widely used in consumer and enterprise electronics, and Haas believes the growing demand for AI will have a spillover benefit. More directly, chipmakers like Nvidia use Arm's designs in products, such as the GH200, which pairs Nvidia's h200 graphics processing unit (GPU) with an Arm-based CPU processor. The more Nvidia sells such products, the more licensing revenue it will have to pay Arm. That said, Arm's AI potential still seems overstated.

Image source: Getty Images.

AI training and inference mainly rely on GPUs, not the CPUs that Arm specializes in. While some products combine the two types of chips, there is no guarantee that this will become a major opportunity for Arm because the company can't raise licensing fees too high without risking its clients switching to alternate CPU designs from rivals such as Intel.

Investors should also remember that Arm is already a massive and mature company, with a 99% market share in premium smartphones and double-digit shares in other categories. For new investors, this is a risk because even if AI-related revenue grows, it may not be enough to counteract potential declines in the company's much larger segments.

Is Arm Holdings stock a buy?

With a forward price-to-earnings (P/E) multiple of 74, Arm Holdings' stock is simply too expensive for what is on offer. While the company may have some potential to benefit from AI-related demand over the next five years, investors shouldn't pay such a premium valuation for a mature company that isn't generating particularly impressive growth.

To put Arm's outrageous valuation in context, Nvidia trades for just 36 times forward earnings despite posting a significantly higher growth rate and enjoying more direct benefits from the AI opportunity.