Arm Holdings(NASDAQ: ARM) It is an important participant in the global semiconductor industry. It designs, develops and licenses its intellectual property (IP) to major chipmakers and original equipment manufacturers (OEMs), who then use the British company’s IP to create central processing units (CPUs) and other products, Such as Graphics Processing Unit (GPU)) and Neural Processing Unit (NPU).
The good news is that Arm’s key position in the semiconductor market has led to impressive gains since it went public in September 2023. Assets have experienced ups and downs.
Arm remains an expensive stock, trading at 297 times trailing earnings. Does this mean investors looking for a growth stock should consider buying Arm despite its pricey trailing price-to-earnings ratio, hoping that a big jump in its profits will help justify its valuation?
We’ll take a closer look at potential catalysts for Arm and consider whether buying this expensive semiconductor stock could be a good long-term move.
Arm licenses its IP to customers for a fee, generating upfront revenue. It also receives royalties from customers for each wafer manufactured using its intellectual property rights. The company has two revenue streams and expects its royalties to provide a stable revenue stream.
The good news for Arm investors is that its licensing and royalty revenue could rise sharply after President Donald Trump announced a $100 billion investment in U.S. artificial intelligence (AI) infrastructure through a joint venture. Increase. Softbankopen artificial intelligence, Oracleand MGX, an artificial intelligence investment company headquartered in the United Arab Emirates. The four companies will provide initial funding for the joint venture, called Stargate, and plan to increase spending to $500 billion over the next four years.
OpenAI’s post announcing the joint venture states that Arm is one of the “key initial technology partners” that will collaborate on the project. This is good news for Arm investors, as Stargate has begun building its first data center in Texas. The joint venture reportedly plans to build a total of 20 data centers, which are being deployed immediately as part of an initial $100 billion investment.
The huge projected spending on U.S. AI infrastructure bodes well for Arm, as the company sees steady growth in demand for its latest AI-optimized chip architecture, Armv9. Smartphone makers are already using its Armv9 CPU architecture to make mobile device processors, driving solid growth in the company’s royalty revenue despite the tepid smartphone market.
For example, Arm’s smartphone royalty revenue increased 40% year-over-year in the second quarter of fiscal 2025 (ending September 30, 2024), outpacing “mid-single-digit growth in smartphone sales, primarily due to Mobile phone application processors are increasingly based on Armv9, and the patent rates are higher.
Last quarter, Armv9 accounted for 25% of the company’s royalty revenue, up from 10% in the same period last year. Going forward, demand for Armv9 is likely to continue to improve. Chief Financial Officer Jason Child said on a November 2024 earnings call that the company was gaining “share from automotive applications and cloud service providers.”
More specifically, Arm architecture’s share of cloud computing increased from 9% in fiscal 2022 to 15% in fiscal 2024. This is not surprising because something like letter and NVIDIA Server CPUs based on Arm architecture are being designed to handle AI workloads in data centers.
In April last year, Alphabet announced the launch of the Axion customized server processor based on Armv9. The tech giant noted that Axion can handle not only general-purpose workloads in servers, but also AI model training and inference. These customized AI processors built using Arm architecture are already available to Google Cloud customers.
At the same time, Arm’s architecture also provides support for Nvidia’s Grace server CPU, which is being deployed in artificial intelligence systems and supercomputers. So, with the huge investments in AI infrastructure announced by the White House, Arm’s AI-specific chip architecture should ideally see a big jump in adoption and help the company land more licensing deals and increase its royalty usage fee income.
But will Arm’s expensive valuation allow it to realize more gains over the next five years?
We’ve seen Arm’s latest AI-focused Armv9 architecture deliver significant revenue growth for the company, despite a significant decline in shipments due to higher royalties. This may also be why Arm’s profit margins have started to trend higher over the past year.
ARM profit margin data provided by YCharts.
The company’s improving bottom line has had a positive impact on its bottom line. The consensus forecast for Arm’s earnings per share for this fiscal year is to grow 23% to $1.56 per share. Stronger growth is expected in the next few fiscal years.
ARM EPS forecast information for the next fiscal year provided by YCharts. EPS = Earnings per share.
Therefore, Arm’s earnings are expected to grow at a compound annual growth rate of 28% from fiscal 2024 to fiscal 2027 (based on fiscal 2023 earnings of $1.27 per share). Assuming that Arm’s profit growth rate can even reach 25% in the two years after fiscal 2027, its net profit may reach $4.19 per share in five years. Of course, this estimate may be conservative if we consider that Armv9’s higher royalties could help it generate stronger earnings growth beyond the next three fiscal years.
But even if Arm’s profits reach $4.19 per share 5 years later, and the stock trades at a P/E ratio of 50x at that time (in line with the average P/E ratio of the US technology industry and well below its expected P/E ratio of 78), its Shares could hit $210. This would be a 28% increase from current levels. However, don’t be surprised to see more upside from the stock, as it appears capable of growing at a more aggressive rate.
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Suzanne Frey is a senior executive at Alphabet and a board member of The Motley Fool. Harsh Chauhan has no position in any of the stocks mentioned. The Motley Fool owns and recommends Alphabet, Nvidia and Oracle. The Motley Fool has a disclosure policy.
What will happen to Arm Holdings stock in 5 years? Originally published by The Motley Fool
