Arm Holdings: A Rising Star in the AI Market

Arm Holdings, a leading chip designer, is rapidly emerging as one of the most prominent artificial intelligence (AI) stocks in the U.S. market. The company's decision to go public last year at a significant valuation has been vindicated by its impressive performance. However, the question remains: how much further can Arm soar?

Despite experiencing a slight 1.4% premarket dip to $112.39 per share on Friday, Arm is poised to retain the majority of its gains from the previous day. On Thursday, the company's stock skyrocketed by 48% after surpassing earnings estimates.

Prior to Arm's initial public offering (IPO) at $51 per share in September, doubts were cast on the British company's potential as a beneficiary of AI spending. Its focus on licensing designs for central processing units (CPUs) and heavy reliance on the smartphone market seemed incongruous with the early dominance of graphics processing units (GPUs) for data centers, manufactured by industry giants like Nvidia.

However, this narrative has undergone a significant shift. Premium smartphones now incorporate AI capabilities that necessitate Arm's cutting-edge chip designs, resulting in higher royalty rates. Additionally, Arm is making notable progress in other sectors such as cloud servers and automotive technology.

J.P. Morgan analyst Harlan Sur expressed confidence in Arm's future prospects. In a recent research note, he stated, "We believe that as AI proliferates across multiple end markets, there is a growing requirement for more compute power/intellectual property, benefiting Arm." Sur subsequently raised his target price for Arm to $100 from $70 and maintained an "Overweight" rating on the stock.

Arm's stock has already surpassed Sur's revised target price and outperformed the predictions of analysts across Wall Street. The average target price currently stands at $91.49, according to Wall Street data.

In conclusion, Arm Holdings has firmly positioned itself as a noteworthy player in the AI market. Despite initial skepticism, the company's strategic positioning and adaptability have allowed it to thrive in an evolving technological landscape. With increasing demand for compute power and intellectual property in the realm of AI, Arm is well-positioned to continue its ascent in the market.

The Future of Arm: Expanding Beyond Smartphones

Arm, the renowned chip design company, is poised for further success, with its potential for growth hinging on the adoption of its chip designs in AI applications beyond smartphones. According to Reuters, both Nvidia and Advanced Micro Devices are currently developing their own Arm-based processors for Windows PCs, with plans to ship them as early as 2025. If AI processing becomes the future standard for devices, Arm stands to emerge as a major player.

Ownership and Trading Volume Considerations

It is worth noting, however, that the majority ownership of Arm—over 90%—rests with Japan's SoftBank Group. While this ownership structure provides some level of support for Arm's share price, it also means that market movements can be amplified due to the limited number of shares available for trading. For instance, on Thursday, Arm's trading volume amounted to 106.5 million shares, a relatively small figure compared to its public float of just over one billion shares and the average trading volume of 8.4 million shares over a 65-day period.

Additionally, the IPO lockup period, which currently prevents company insiders from selling their shares, is set to expire on March 12.

Eye-Popping Valuation

Arm's valuation is undeniably impressive. Based on FactSet data, the stock currently trades at an astonishing trailing price-to-earnings multiple of 223. Looking ahead, it trades at a multiple of approximately 79 times based on forward price-to-earnings. While Nvidia has managed to compress similar multiples rapidly by consistently exceeding earnings expectations, achieving such feats sets a high bar in any case.

The Challenge posed by RISC-V

Arm also faces a challenge from the open-source RISC-V chip architecture, which poses a threat to its ability to continue raising licensing fees. Overcoming this challenge and maintaining its dominance will be a key test for Arm.

While Arm is currently positioned as one of the winners in the AI landscape, there are no guarantees that it will retain its standing.