Nvidia and Arm Holdings are the two best semiconductor stocks to buy for exposure to the fast-growing AI space.
Artificial intelligence (AI) is poised to be one of the biggest disruptive secular growth trends of all time. Most sources project the global AI market to have a compound annual growth rate (CAGR) in the 30% to 40% range through 2030, with 2030 market sizes ranging from over $800 billion to more than $1 trillion.
The AI revolution had been underway in recent years but just kicked into high gear in early 2023. This occurred following the advent of generative AI, which greatly expanded the potential use cases for AI. Generative AI wowed the tech world when OpenAI released its ChatGPT chatbot in late 2022.
There are several main ways to invest in AI. This article focuses on companies that are largely developing and supplying semiconductors, or “chips,” and other technology to enable AI capabilities.
Best AI chip/technology stocks
| Company | Market Cap | Forward P/E Ratio | Wall Street’s Projected 5-Year Annualized EPS Growth | Year-to-Date 2024 Return | 10-Year Return |
|---|---|---|---|---|---|
| Nvidia (NVDA 4.55%) | $3.2 trillion | 47 | 46.4% | 161% | 28,220% |
| Arm Holdings (ARM 4.56%) | $142 billion |
86 |
31.2% | 80% | N/A* |
| S&P 500 Index | N/A | N/A | N/A | 19% | 241% |
Data sources: Yahoo! Finance and YCharts. Data to Aug. 23, 2024. P/E = price-to-earnings. EPS = earnings per share. *Arm held its initial public offering (IPO) in September 2023.
Let’s put the 10-year percentage gains in monetary terms. Here’s how much $1,000 invested a decade ago in each of the following would be worth now:
- Broader market (S&P 500): $3,410
- Nvidia: $283,200 (yep, more than a quarter of a million dollars)
1. Nvidia
To call Nvidia “dominant” in the AI chip space is an understatement. The company’s graphics processing units (GPUs) are the gold standard for accelerating the processing of AI workloads in data centers.
By all accounts, Nvidia has well over a 90% share of the market for AI GPU chips for data centers and over 80% share of the overall data center AI chip market. Advanced Micro Devices CEO Lisa Su projects the fast-growing data center AI chip market will reach $400 billion in revenue by 2027, which equates to an average annual growth rate of about 73%.
Nvidia isn’t a pure play on AI, but it’s as close as you can get in the semiconductor space. Its data center market platform accounted for 87% of its revenue in its quarter ended in late April, and this business largely supplies chips and related technology (including networking tech and software) for enabling AI and high-performance computing.
AI is also enhancing Nvidia’s offerings in its other platforms, which include computer gaming (10% of last quarter’s revenue), professional visualization (1.9%), and auto and robotics (1.5%).
Nvidia is scheduled to report its results for the second quarter of fiscal 2025 (ended late July) on Wednesday, Aug. 28, after the market close. Management guided for revenue to grow 107% year over year to $28 billion. It also guided (indirectly by providing a bunch of inputs) for adjusted earnings per share (EPS) of $6.22, or 130% growth.
2. Arm Holdings
Arm, based in the U.K., designs architectures for central processing units (CPUs) and licenses those designs and related intellectual property (IP) to customers. Its customers include many of the biggest names in consumer technology and semiconductors, including Apple, Nvidia, and Qualcomm.
Arm, founded in 1990, was critical in enabling the smartphone revolution. Its chip architecture is very energy-efficient, allowing smartphones to have good battery performance, which led to their fast adoption. Arm-based chips are found in about 99% of smartphones, as well as in countless other small form-factor products.
In recent years, the company has expanded into higher-value markets, such as data center servers, AI accelerators, and smartphone applications (apps) processors. AI is driving growth in all these markets. The company said in its most recent earnings report that “AI’s substantial energy requirements are driving growth in Arm’s compute platform, which is the most power-efficient solution available.”
In late July, Arm reported its results for its first quarter of fiscal 2025, which ended in late June 2024. Revenue surged 39% year over year to $939 million, sprinting by the $908 million Wall Street consensus estimate. License revenue rocketed 72% to $472 million, and royalty revenue jumped 17% to $467 million.
The even better news for investors is that Arm’s profit grew even more than its revenue, which means its profit margin continued to expand. Adjusted for one-time items, its net income was $419 million, or $0.40 per share, up a whopping 67% year over year. That result easily beat the $0.34 analysts had expected.
I included the adjusted net income figure to highlight how extremely profitable Arm is. Its adjusted profit margin in the quarter was 44.6% ($419 million divided by $939 million).
What about valuations for Nvidia and Arm stocks?
Nvidia stock is trading at 47 times its projected earnings for the current fiscal year. That’s high in a vacuum — but reasonable for a company that Wall Street expects to grow earnings at an average annual rate of 46.4% over the next five years. Moreover, Nvidia regularly exceeds earnings estimates easily, so 46.4% is likely to prove too low.
Arm’s stock is incredibly pricey. It’s trading at 86 times its projected earnings for the current fiscal year. This is very high not only in a vacuum but also for a company that Wall Street projects will grow earnings at an average annual pace of 31.2% over the next five years.
So, why do I consider Arm stock the second-best (behind Nvidia) AI tech stock to buy now? I’m working on a full article on why it’s worth paying up for Arm stock, so suffice it to say that there are good reasons to believe that Wall Street is significantly underestimating Arm’s earnings growth potential. In each of the company’s four quarters as a public company, it has cruised by the analyst consensus earnings estimate.
That said, before making an investment decision, some investors might want to watch Arm for another couple of quarters to see whether it keeps churning out robust top- and bottom-line growth and sailing by Wall Street’s estimates.
