Investors appear to be shifting money away from top AI chip stocks and towards their lesser known peers.
NVIDIA (NVDA -7.73%) The company has delighted shareholders with a nearly 1,000% return since the start of 2023, but the AI chip leader’s shares fell 6.4% on Thursday, a rare post-earnings drop for investors.
The company beat market expectations for sales and profits, but the sharp drop in its stock price appears to be largely due to concerns about valuation and growth.
NVIDIA’s market cap is now at $3 trillion, and while it’s still posting impressive growth, the stock’s upside potential has been limited. Second-quarter revenue grew 122% to $30 billion, and adjusted earnings per share increased 152% to $0.68.
Another surprising aspect of the market reaction to the news was that even as Nvidia’s stock price fell, many of the stocks related to the company’s AI chips rose during the trading hours, with one stock in particular being a big winner: Arm Holdings. (arm -5.73%)The company’s shares closed up 5.3% despite no company-specific news.
In other words, investors seem to think that Nvidia’s results are good news for the AI sector as a whole because they showed strong demand for the company’s chips, but they no longer seem to think that Nvidia is the best way to ride the AI boom.
Is Arm a better AI stock than Nvidia right now? Let’s take a closer look at the two companies to find out.
Image source: Getty Images.
What you need to know about Nvidia and Arm
Nvidia and Arm work closely together, and perhaps no other company has benefited more directly from Nvidia’s success than Arm.
Nvidia is using Arm’s CPU architecture for a number of components, notably its GH200 Grace Hopper superchip, which Nvidia says is designed for large-scale AI and high-performance computing applications.
Nvidia is also using Arm’s Grace CPUs in its next-generation Grace Blackwell Superchips, part of the Nvidia GB200 NVL72, which features liquid cooling and delivers up to 30x performance improvement over the previous Nvidia H100 GPU. Arm CEO Rene Haas said Grace Blackwell will be “a really great chip for the AI data center.”
One reason Arm is attractive to investors looking to diversify from Nvidia is that its unique business model has meant it has yet to reap most of the benefits from the explosion in demand for AI chips.
Unlike its chip peers, Arm makes money by licensing its architecture to companies like Nvidia, who then incorporate that into their own chips. Arm makes money in two ways: by selling licenses, which it earns revenue from, and by later earning revenue in royalties when those products start selling.
Arm has yet to collect significant royalties from the generative AI boom, because there tends to be a two- to three-year lag between revenue from a new license and royalties from products that contain that license.
But licensing revenue is already booming, growing 72% to $472 million in the most recent quarter, a surge that Arm attributes to several high-value licensing deals with pioneering companies.
Royalties, which make up the bulk of Arm’s revenue, should surge in 2026 or 2027 given the surge in licensing revenue.
Is Arm a better AI stock than Nvidia?
Investors appeared to be switching from Nvidia to Arm on Thursday, but you might be surprised to learn that Nvidia’s stock is still the cheaper of the two: Nvidia is traded at 53 times trailing earnings, based on adjusted EPS, while Arm is traded at 94 times.
Also, on a price-to-earnings (P/S) basis, Arm is more expensive at 38 times sales than Nvidia at 32 times.
While both companies are generating huge profits, Nvidia still has the faster growth rate of the two, but that could change in the coming quarters once Arm royalty revenue starts coming in.
The biggest advantage Arm has over Nvidia is the likelihood of its stock price doubling. Arm’s market cap is much lower than Nvidia’s, and the market doesn’t seem to fully understand Arm’s potential as Nvidia’s does. Arm has a greater chance of surprising with an upside in its stock price.
Still, selling Nvidia and buying Arm doesn’t seem like the right move: Nvidia’s competitive advantage remains as strong as it was before this report, if not stronger.
While Nvidia’s stock price probably won’t double again anytime soon, it’s still worth including in an AI stock portfolio. Owning shares of both Nvidia and Arm, the dominant leaders in their respective fields, makes the most sense for AI stock investors.
