Morgan Stanley is calling for significant upside in Arm Holdings stock.
Semiconductor stocks are among the hottest choices for artificial intelligence (AI) investors right now. While companies such as Nvidia, AMD, and Broadcom often garner outsize attention in the chip space, smart investors realize that there are other opportunities that present potentially lucrative returns over the long run.
Recently, Lee Simpson of Morgan Stanley upgraded his price target for Arm Holdings (ARM -6.63%) to $190 — implying roughly 27% upside from trading levels as of market close on July 26.
Let’s dig into how Arm is making waves in the chip space and assess how the company stands to benefit from the ongoing AI boom.
Don’t call it a comeback
The last few years have been fascinating for Arm. It was a privately held company owned by Japanese investment firm SoftBank for quite some time.
Back in 2020, semiconductor darling Nvidia tried to acquire Arm for $40 billion. However, regulatory hurdles stood in the way of this deal coming to fruition — ultimately leading Nvidia to walk away from the deal and abandon its ambitions with Arm in early 2022.
By late 2023, Arm joined many of its peers as a publicly traded company, and investors finally got a glimpse into the company’s operations.
Candidly, an initial review of Arm’s F-1 filing left little to be desired. At the time, the company was going through a bit of a rough patch, underscored by inconsistent financial performance, and had even begun showcasing decelerating growth across revenue and profits.
However, since demand for AI-powered services has experienced surging demand over the last year or so, Arm’s business has started to witness newfound life.
ARM Revenue (Quarterly) data by YCharts
As depicted in the chart, investors can see that Arm’s revenue, gross profit, and free cash flow have all sharply rebounded over the last year. Although the company was in desperate need of being able to show a return to growth, I would not shortchange the company’s current trajectory simply because AI is the hottest ticket in the tech world right now.
A closer look at Arm’s addressable market suggests the company’s return to growth narrative is just beginning.
Image source: Getty Images.
Big tailwinds are just an arm’s length away
According to its F-1 filing, Arm defines its total market opportunity as “all chips that can contain a processor and, therefore, our TAM includes the main controller chips in smartphones, PCs, digital TVs, servers, vehicles and networking equipment.”
Per Arm’s estimates, its addressable market was worth roughly $203 billion at the end of 2022. Moreover, the company boasts that at the time of its IPO in late 2023, Arm had acquired 49% market share.
Considering how much demand has risen for AI chips in just the last year alone, I’m cautiously optimistic that the figures from Arm’s original filings could be conservative.
Regardless, I think the more important aspect to analyze here is the company’s market share. At the time of its public company debut, Arm owned nearly half of its market. And yet, as seen in the presentation, Arm recently notched its highest-ever revenue growth for its fiscal fourth quarter (ended March 31).
Furthermore, the company ended the year with $2.5 billion in remaining performance obligations — or revenue sitting in backlog that is yet to be recognized.
Data source: ARM investor relations.
Is Arm stock a good buy right now?
The last thing to point out with Arm is its valuation. With a forward price-to-earnings (P/E) ratio of 95, Arm stock is pretty pricey — even for a growth stock. Moreover, even with its forward P/E falling significantly from prior highs, the trends depicted indicate a fair amount of valuation expansion in recent months.
ARM PE Ratio (Forward) data by YCharts
With all that said, the company is generating 47% growth year over year and sitting on billions of future committed revenue. Given this level of growth, I think it’s likely that Arm stands to gain even further market share over the next several years — making it hard to gloss over Arm’s potential.
Investors with a long run time horizon don’t need to worry about the exact price point they buy a stock. Rather, by adopting a dollar-cost averaging approach to investing, you can continually buy a stock at different prices throughout its growth story and reap the gains over a long-term horizon.
I see Arm as a compelling opportunity for investors looking for exposure to the chip space and broader AI themes, and very much think the company’s best days are ahead.
