3 Reasons Arm Holdings Is a Must-Buy for Long-Term Investors

Arm Holdings (NASDAQ: ARM) has emerged as a top AI stock following its initial public offering in September 2023. The chip design company, which specializes in power-efficient CPU architecture, seemed to be initially misunderstood by investors, but the stock has since tripled from its IPO price.

Arm's shares are expensive today, trading at a price-to-sales ratio of 47, but the stock still offers tremendous long-term potential, especially as the influence of artificial intelligence (AI) spreads. Let's take a look at three reasons why Arm is a must-own stock for long-term investors.

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1. Arm is in Stargate and other key projects

Arm stock got a shot in the arm (no pun intended) when the Stargate joint venture project was announced shortly after President Trump took office.

Arm was named as one of five key initial technology partners, along with Microsoft, Nvidia, Oracle, and OpenAI, for the new venture, which pledges to invest at least $100 billion in new AI infrastructure. Arm already partners directly on components with Microsoft, Nvidia, and Oracle, and OpenAI uses its technology.

Softbank, which is Arm's majority owner, is also the key financial partner for the project, and Softbank's influence across the tech world shouldn't be overlooked by investors. In fact, Softbank, OpenAI, and Arm have also partnered on an AI project in Japan called Cristal Intelligence, whose goal is to develop Advanced Enterprise AI.

At the heart of Cristal Intelligence is an investment in AI agents that perform tasks without human assistance, and those agents will require increasing compute power as they scale up. That's where Arm plays a key role as its architecture is the most effective at conserving power, and that advantage will continue to drive its adoption in the AI era.

2. It can excel at both the data center and the edge

So far, the vast majority of AI spending has taken place at the data center where hyperscalers and other tech companies are spending billions on Nvidia GPUs. Arm has benefited from that growth as its Grace CPUs are in Nvidia's Grace Hopper and Grace Blackwell Superchips. It also licenses its technology to the major cloud computing companies for their own chips, including Amazon's Graviton, Microsoft Cobalt, and Google Axion.

Arm's market share in the cloud has increased from 9% to 15% in the last two years, and the market value of that opportunity has risen from $16 billion to $21 billion.

However, Arm's biggest opportunity in AI could be at the edge, meaning devices that are being used directly by consumers including handheld electronics like smartphones, automobiles, appliances, and robotics. This is Arm's traditional strength as devices that run on a battery tend to use Arm-based chips since they're better at conserving power.

Edge AI, which includes technologies like Apple Intelligence, is expected to grow significantly over the coming years, and that will favor Arm.

3. Its royalty pipeline will pay off for years

Arm has a unique business model in the semiconductor industry. It licenses its technology and then collects royalties when the chips containing that technology are sold. As a result, there's a lag between license revenue and royalties beginning to be earned from that license of two to three years, but royalty revenue collected from a single license can continue for over a decade.

In fact, half of Arm's current royalty revenue comes from products launched 10 years ago or more. While the company is benefiting from the AI revolution, the payoff will come over a long period of time rather than in a handful of quarters as it has for Nvidia.

Arm's revenue growth of 19% in the third quarter might seem modest for a stock with its valuation, but it's paying the way for a boom over the next decade especially as new chips like its v9 and compute subsystems (CSS) command a higher royalty rate than older chips.

Between its leading CPU architecture, relationships with cloud hyperscalers, and promising royalty pipeline, Arm is a must-own stock for the AI boom.

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Jeremy Bowman has positions in Arm Holdings. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.