Sell Nvidia, Buy Arm? #NewsUnitedStates

Nvidia (NASDAQ: NVDA) has delighted its shareholders with a return of nearly 1,000% since the start of 2023, but Thursday brought investors a rare post-earnings drop as the AI chip leader closed down 6.4% for the day.

While the company beat headline estimates on the top and bottom lines, the sell-off in the stock seemed to have more to do with valuation and growth concerns.

Nvidia is now worth $3 trillion, meaning the upside for the stock has become more limited even as it’s still posting blowout growth. Revenue was up 122% in the second quarter to $30 billion, and adjusted earnings per share were up 152% to $0.68.

What was also surprising about the market’s reaction to the news is that although Nvidia shares fell, many of its AI chip stock peers were up for most of the session, and one, in particular, was a big winner. That was Arm Holdings (NASDAQ: ARM), which finished the day up 5.3% even though there was no company-specific news out on the stock.

In other words, investors seem to think that Nvidia’s results were good news for the broader AI sector as they indicated strong demand for its chips, but they no longer see Nvidia as the best way to play the AI boom.

Is Arm a better AI stock to own than Nvidia now? Let’s take a closer look at the two companies to find out.

What you should know about Nvidia and Arm

Nvidia and Arm work closely together. Arguably, no other company has benefited more directly from Nvidia’s success than Arm.

Nvidia uses Arm’s CPU architecture in a number of its components, most notably the GH200 Grace Hopper Superchips, which, according to Nvidia, are designed for giant-scale AI and high-performance computing applications.

Nvidia is also using Arm’s Grace CPU for its next-generation Grace Blackwell Superchips, which feature liquid cooling and are part of the Nvidia GB200 NVL72 that will provide up to a 30x performance increase over traditional Nvidia H100 GPUs. Arm CEO Rene Haas said Grace Blackwell would be a “very, very good chip for us in the AI data center.”

Part of Arm’s attraction to investors looking to diversify away from Nvidia is that its unique business model means it’s yet to capture much of the benefit from the explosion in demand for AI chips.

Unlike its chip stock peers, Arm makes money from licensing its architecture to companies like Nvidia, which then put it in their chips. Arm collects revenue in two ways. It makes money when it sells licenses, and it makes money through royalties later on when those products start to sell.

There tends to be a lag of two to three years between collecting revenue from a new license and the royalty from the product with that license, so Arm has yet to collect significant royalties from the generative AI boom.

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However, licensing revenue has already soared, up 72% to $472 million in its most recent quarter. Arm attributed that surge to multiple high-value license agreements from thought-leading companies.

Based on the jump in licensing revenue, we should see a surge in royalties, which generally make up the majority of Arm’s revenue, in 2026 or 2027.

Is Arm a better AI stock than Nvidia?

While investors seemed to be rotating from Nvidia to Arm on Thursday, you might be surprised to learn that Nvidia is still the cheaper stock of the two. On a trailing price-to-earnings basis, Nvidia is now valued at a multiple based on adjusted EPS of 53, compared to Arm at 94.

Arm is also more expensive on price-to-sales basis at a multiple of 38, compared to Nvidia at 32.

Both companies generate huge margins, but Nvidia is still the faster growing of the two. However, that could change in the coming quarters as Arm’s royalty revenue starts to kick in.

The biggest advantage Arm has over Nvidia is that it’s easier for the stock to double, as its market cap is much lower than Nvidia’s and its potential doesn’t seem as fully understood by the market as Nvidia’s. Arm has the greater potential to surprise to the upside.

Still, selling Nvidia to buy Arm doesn’t seem quite right; Nvidia’s competitive advantages are just as strong as they were before the report, if not stronger.

Nvidia stock probably won’t double again anytime soon, but it still deserves a place in any AI stock portfolio. Holding shares of both Nvidia and Arm, two dominant leaders in their respective categories, makes the most sense for AI stock investors.

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Jeremy Bowman has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Nvidia. The Motley Fool has a disclosure policy.

Sell Nvidia, Buy Arm? was originally published by The Motley Fool