Arm Holdings (NASDAQ:ARM) Is A Top Goldman Sachs Phase 2 AI Stock Up 119% YTD
We recently made a list of Goldman Sachs’ Best Phase 2 AI Stocks: Top 24 High Conviction AI Stocks. In this piece, we will look at where Arm Holdings (NASDAQ:ARM) ranks among the list of Goldman Sachs' Phase 2 AI stocks.
While consumer technology stocks had soared in the aftermath of the coronavirus pandemic, back then, their share price gains were due to. the growing demand for technology products and services due to lock downs. Now, big technology stocks have persisted in their strong performance despite high interest rates since they have been judged by the market as the top innovators and performers in the artificial intelligence industry.
Since AI is somewhat of a ubiquitous technology, its impact is on several industries. So far, we’ve seen most of the stock market returns related to AI directly tied to just one stock. This stock continued to be the fifth most trending AI stocks as recently as in mid October and its share price returns are nothing short of unbelievable. From its bottom in October 2022 when the split adjusted share price was a mere $11.23, the shares have gained a stunning 1,100%. In other words, if you had invested just $100 back then in the shares and then held onto them for dear life, your investment would be worth $1,200 today.
This is the magic of AI, a technology that has caught Wall Street and retail investors alike by storm. However, AI’s impact, and its enablement, aren’t limited to the GPU designer we’ve mentioned above. While GPUs are the ‘oil’ for this technology, a wide variety of other components from data center infrastructure, networking equipment, connectivity, and energy all will have to play their part if OpenAI CEO Sam Altman’s plans of initially building as many as 7 AI data centers across the US, with each data center guzzling an unbelievable 5 Gigawatts of electricity, are to come to fruition.
This then makes us ask, what are such stocks that might enable 35 Gigawatts of AI data centers across the US? After all, in order to meet the world’s demand for AI chips, Altman believes that an unfathomable $7 trillion will need to be spent for building 36 chip manufacturing fabs and additional AI data centers. This money has to be spent somewhere, and therein lies the answer to our question. Things get clearer when we look at a detailed research report from investment bank Goldman Sachs. This report segregated the AI sector into four categories.
The first category only included Wall Street’s AI darling, the second was made of AI capacity providers like server companies, other semiconductor firms, and utilities, the third included firms that sell AI products and software, and the fourth category firms were those that will benefit from AI adoption. In its report, the investment bank shared that year to date in July, the first category had returned 139%. As of mid October, this category has gained 179% on the stock market, so safe to say returns have accelerated despite some turbulence in between. By July, the second group of firms was also doing well. Its returns ranged between ~-8% to ~50%, with the average stock having delivered 22%.
Zooming into these firms, the utility sector is one which had particularly impressed the bank. It shared that utilities were the best performing sector in the flagship S&P index between March and May courtesy of their 16% returns. Their three month returns ranked in the 98th percentile since 2022 and were the third highest after 2003 and 2020 rallies. This outperformance is unsurprising given the strong investments in data centers that have taken the US by storm this year.
These investments have led to estimates suggesting that America’s data center hub, Northern Virginia, will require 11,000 megawatts of electricity by 2035 – demand which has already spurred $5.2 billion in investments for transmission lines and coal fired power plants. Estimates from Boston Consulting Group believe that by 2030, AI will account for 16% of America’s energy consumption and touch 130 gigawatts. For a detailed look at the link between electricity use and data centers, you should read 15 Best Data Center Stocks To Buy According to Jefferies, Citi and Wall Street Analysts.
The bustling optimism surrounding AI is also reflected in revenue estimates. Goldman’s September 2024 research shows that 2025 revenue estimates of semiconductor firms, software enablers, and hardware firms except semiconductors are roughly 2.3x, 2.05x, and 1.8x over 2019 levels, respectively. Similarly, non semiconductor hardware companies have seen their revenue forecasts for Q4 2025 jump to $450 billion for a $380 billion gain over Q1 2024’s $70 billion. Makes us wonder whether it’s this group of companies that might see a stock mirror the 1,100% returns of Wall Street’s AI darling.
Our Methodology
To make our list of Goldman Sachs’ best phase 2 AI stocks, we ranked the 20 stocks with the highest year to date returns and some other big tech and data center names that have announced multi billion dollars in capital expenditure by their year to date performance.
For these stocks, we also mentioned the number of hedge fund investors. Why are we interested in the stocks that hedge funds pile into? The reason is simple: our research has shown that we can outperform the market by imitating the top stock picks of the best hedge funds. Our quarterly newsletter’s strategy selects 14 small-cap and large-cap stocks every quarter and has returned 275% since May 2014, beating its benchmark by 150 percentage points. (see more details here).
A close up of a confident investor making a decisive transaction in the stock market.
Arm Holdings (NASDAQ:ARM)
Year To Date Share Price Gain: 119.76%
Number of Hedge Fund Investors in Q2 2024: 38
Arm Holdings (NASDAQ:ARM) is a British semiconductor design IP company. While the firm does not sell its own processors, its blueprints power the vast majority of the world’s smartphone processors. Arm Holdings (NASDAQ:ARM) also offers designs and cores for GPUs and other chips. Its exposure to the AI industry comes particularly because of custom chips. Advances in semiconductor fabrication have meant that while traditionally x86 processors were more powerful due to instruction set architecture (ISA) differences, newer chip manufacturing technologies enable manufacturers to increase core counts within a small package size to maintain efficiency and increase performance. As a result, Arm Holdings (NASDAQ:ARM)’s designs, which were originally used for efficiency requiring applications such as smartphones, are now a mainstay of custom data center chip designs for big ticket names such as Amazon, Google, and Alibaba. This means that Arm Holdings (NASDAQ:ARM) has a wide moat and exposure to AI data centers, making it unsurprising that at one point, NVIDIA was interested in buying the firm. However, a long term threat could come from the open source RISC-V model disrupting the firm’s business.
Bireme Capital mentioned Arm Holdings (NASDAQ:ARM) in its Q4 2023 investor letter. Here is what the fund said:
“Another stock we bet against in the second half of 2023 was ARM Holdings. We find the valuation to be far too rich at more than 20x sales and 100x FY 2023 operating income. To garner such a large multiple in the public markets, majority owner Softbank seems to have pulled out all the short-term levers at its disposal. From the FT:
Arm is seeking to raise prices for its chip designs as the SoftBank-owned group aims to boost revenues ahead of a hotly anticipated initial public oering in New York this year. The UK-based group, which designs blueprints for semiconductors found in more than 95 per cent of all smartphones, has recently informed several of its biggest customers of a radical shift to its business model, according to several industry executives and former employees. These people said Arm planned to stop charging chipmakers royalties for using its designs based on a chip’s value and instead charge device makers based on the value of the device. This should mean the company earns several times more for each design it sells, as the average smartphone is vastly more expensive than a chip.
In our view this was a transparent attempt to boost revenue growth ahead of the IPO. This might work as a one-time boost to sales, but it is not sustainable and will anger and alienate customers. ARM’s largest customers increasingly choose to license just the ARM instruction set architecture (ISA) rather than purchase ARM’s o-the-shelf chip designs. They prefer to design their own chips so they can better optimize their hardware with their software, as Apple has done to great effect with its custom silicon. It is hard to imagine ARM getting significantly more revenue share while their value-add diminishes.”
. . . .We believe ARM’s short-term price increases are unlikely to be converted to long-term revenue growth, but this is what is required to justify the current valuation.”
Overall ARM ranks 6th on our list of Goldman Sachs' top phase 2 AI stocks. While we acknowledge the potential of ARM as an investment, our conviction lies in the belief that some AI stocks hold greater promise for delivering higher returns and doing so within a shorter timeframe. If you are looking for an AI stock that is more promising than ARM but that trades at less than 5 times its earnings, check out our report about the cheapest AI stock.
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Disclosure: None. This article was originally published on Insider Monkey.