Think Arm Is Too Expensive? 1 Thing You Need To Understand About the Chip Stock

Like the rest of the semiconductor sector, Arm Holdings (ARM +4.74%) endured a brutal sell-off on Thursday.

Shares of the chip stock, which is best known for licensing its power-efficient CPU architecture, lost 13% on Thursday following its fiscal second-quarter earnings report.

That sell-off was largely driven by the broader plunge in tech stocks on concerns about potential data center restrictions following the midterm elections, though Arm shares fell in after-hours trading on Wednesday after the report came out.

Arm topped estimates on the top and bottom lines, but investors were disappointed with weak growth in royalty revenue, which rose 8% to $670 million, a function of a slow smartphone market. Arm dominates the smartphone CPU market with virtually 100% market share, and it’s still the biggest source of royalty revenue for the company. However, higher memory prices have pressured smartphone shipments, and smartphone royalty revenue was roughly flat in the year.

Nonetheless, the company’s growth markets continued to deliver strong results. Data center royalty revenue doubled year-over-year, and now makes up roughly a quarter of total royalty revenue. Physical AI royalty revenue, meanwhile, was up 50%, driven by growth in the auto market.

Guidance for royalty revenue growth in the third quarter was also disappointing, as the company forecast just low-single-digit royalty growth due to weakness in the smartphone segment and tough comparisons with the quarter a year ago.

License revenue in the quarter was strong, up 50% to $773 million, driven by an increase in long-term agreements. Arm’s total revenue rose 27% to $1.44 billion, topping the consensus at $1.38 billion. On the bottom line, adjusted earnings per share rose from $0.39 to $0.52, which beat estimates at $0.48.

Image source: Getty Images.

What was missing from the quarterly numbers

Arm stock soared in March when the company announced that it was getting into silicon for the first time. Historically, the company has just licensed its CPU architecture and collected revenue on royalties. Now, it will design its own chips like fabless peers such as Nvidia, AMD, and Broadcom.

Arm introduced the Arm AGI CPU with Meta Platforms as its lead partner. The data center CPU has a higher performance per watt than any current competitors on the market, and will go into production in Arm’s fiscal fourth quarter, which ends next March. The company already has more demand than it can handle and raised its revenue guidance from the chip through fiscal 2028 from $1 billion to $2 billion. By fiscal 2031, it expects $15 billion in annual revenue from Arm AGI CPU.

The company said in its shareholder letter that it’s more confident in hitting that $2 billion forecast, and it’s focused on “expanding capacity to meet growing customer demand.”

CPU demand is directly correlated with AI inference, which is what powers agentic AI. There’s a lot of upside potential for the new AGI CPU if a product like Meta’s Muse gains significant adoption.

Arm CFO Jason Child explained that every Muse user required a single CPU core devoted to it. If Meta were able to convert every one of its roughly 3.5 billion social media users into Meta users, it would need to buy 3.5 billion Arm AGI CPU cores from Arm. Child said that cores are priced between $10 and $20, which would translate into $35 billion-$70 billion in revenue.

That’s the ceiling from Muse, and not every Facebook user is going to adopt Muse, of course, but the example is illustrative of Arm’s potential growth with the new CPU. It also shows that the addressable CPU market is potentially much larger than the $100 billion or $200 billion previously estimated, as there are several personal AI agents on the market and agentic AI products will certainly expand.

ARM – Arm Holdings

$174.62+$7.90 (+4.74%)

NASDAQ · As of 4:00 PM ET 11/06/26

Is Arm a buy?

Arm stock has fallen sharply since it peaked in June, following a broad rally in chip stocks and excitement about CPU demand. It’s still expensive, with a price-to-earnings ratio of around 80, but the discussion of the stock seems to ignore the upside potential related to the Arm AGI CPU.

While investors will still have to wait a couple of quarters to get some meaningful numbers on the AGI CPU, it could bring in much more than $15 billion in revenue by fiscal 2031. At this point, owning Arm for some exposure to the agentic AI upside makes sense, even if the stock otherwise looks expensive.

Source: www.fool.com — article syndicated from the publisher’s feed; all rights remain with the original publisher.