Sell ​​Nvidia, Buy Arm? | The Pied Fool

Nvidia (NVDA -6.49%) has delighted shareholders with a return of nearly 1,000% since the start of 2023, but Thursday gave investors a rare post-earnings drop as the AI ​​chip leader closed up 6.4% for the day.

While the company beat headline estimates on the top and bottom lines, the stock selloff appeared to have more to do with valuation and growth concerns.

Nvidia is now worth $3 trillion, meaning the stock’s upside has become more limited, even if it’s still seeing explosive growth. Revenue rose 122% in the second quarter to $30 billion, and adjusted earnings per share rose 152% to $0.68.

What was also surprising about the market’s reaction to the news is that while Nvidia shares fell, many of its fellow AI chip stocks were up for most of the session, and one special, was a big winner. That was it Arm holds (ARM -6.10%)which ended the day up 5.3%, although there was no company-specific news on the stock.

In other words, investors seem to think Nvidia’s results were good news for the broader AI sector because 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 right now? Let’s take a closer look at the two companies to find out.

Image source: Getty Images.

What you should know about Nvidia and Arm

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

Nvidia uses the Arm processor architecture in a number of components, notably the GH200 Grace Hopper superchips, which Nvidia says are designed for giant-scale AI and high-performance computing applications.

Nvidia is also using Arm’s Grace CPU for the new generation of Grace Blackwell superchips, which feature liquid cooling and are part of the Nvidia GB200 NVL72, which will offer up to 30 times the 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 appeal to investors looking to diversify away from Nvidia is that its unique business model means it has 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, who then put it into their chips. Arm collects revenue in two ways. They make money when they sell licenses and they make money through royalties later when those products start selling.

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

However, licensing revenue is already up 72% to $472 million in its most recent quarter. Arm attributed this growth to several high-value license agreements from leading companies.

Based on the increase in licensing revenue, we should see an increase in royalties, which generally account for the bulk of Arm’s revenue, in 2026 or 2027.

Is Arm a better AI stock than Nvidia?

While investors seemed to be pivoting from Nvidia to Arm on Thursday, you might be surprised to learn that Nvidia is still the cheaper stock of the two. Based on last-minute price-to-earnings, Nvidia is now valued at an adjusted EPS-based multiple of 53, compared to Arm’s 94.

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

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

The biggest advantage Arm has over Nvidia is that it’s easier for the stock to double because its market cap is much smaller than Nvidia’s and its potential doesn’t seem as well understood by the market as that of Nvidia. The arm has more potential to catch up.

Selling Nvidia to buy Arm doesn’t seem quite right, though; Nvidia’s competitive advantages are as strong as before the report, if not stronger.

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