The
AI
buzzword
is
misleading
investors
on Arm‘s
true
potential
as
a
technology
stock,
says
Morningstar
analyst
Javier
Correonero
in
a
new
report
on
the
NYSE-listed
British
company
Although
Arm
(ARM)
has
many
virtues
to
be
excited
about,
its
share
price
is
not
one
of
them.
After
the
company
reported
earnings
on
February
7,
its
shares
soared
more
than
50%
and
have
traded
close
to
$140
since,
propelled
by
an
exaggerated
artificial
intelligence
narrative
combined
with
excitement
about
recent
increases
in
royalty
rates
after
the
introduction
of
its
newest
architecture,
Armv9.
While
Arm
is
executing
well
and
is
an
AI
beneficiary,
we
believe
its
AI
story
is
ancillary,
and
we
do
not
expect
an
earnings
inflection
that
is
anywhere
close
to
that
of
Nvidia.
Morningstar
Metrics
for
Arm
Stock
•
Fair
Value
Estimate:
$57
•
Morningstar
Rating:
★
•
Morningstar
Economic
Moat
Rating:
Wide
Arm
Needs
to
Keep
Spending
on
R&D
The
current
share
price
neglects
Arm’s
need
to
continue
investing
in
research
and
development
to
keep
growing
its
top
line
and
puts
too-high
expectations
on
growth
and
margins,
in
our
view.
Our
$57
fair
value
estimate
assumes
a
17%
revenue
compound
annual
growth
rate
(CAGR)
over
the
next
decade
and
a
44%
terminal
GAAP
operating
margin,
compared
with
the
22%
CAGR
and
55%
operating
margin
needed
to
justify
a
$140
share
price.
Although
the
latter
scenario
would
result
in
a
medium-term
boost
to
Arm’s
financials,
we
believe
it
would
create
long-term
risks,
as
the
firm
would
need
to
quintuple
its
royalty
rates
in
just
eight
years,
extracting
too
many
dollars
from
the
value
chain
and
encouraging
customers
to
look
for
alternative
architectures
such
as
RISC-V.
Given
a
90
times
adjusted
2025
price/earnings
ratio
(excluding
share-based
compensation)
and
170
GAAP
2025
P/E
ratio,
we
believe
investors
have
much
to
lose
and
little
to
gain
by
buying
Arm
shares.
What
the
Market’s
Saying,
What
Morningstar’s
Saying
Key
Takeaways
from
Our
Arm
Report
•
Although
semiconductor
ecosystem
providers
like
Arm
will
benefit
from
AI,
they
won’t
to
the
same
extent
as
Nvidia,
given
their
different
business
models
and
lower
operating
leverage
and
pricing
power.
Put
simply,
Nvidia
does
not
need
to
spend
50
times
more
in
software
or
pay
50
times
more
to
Arm
in
royalties
to
design
an
“AI
chip”
that
sells
for
50
times
more.
We
expect
Arm’s
profits
will
likely
grow
more
in
line
with
revenue.
•
Arm
faces
an
innovation
versus
profit
margin
paradox.
If
it
aims
to
gain
market
share
and
keep
raising
royalty
rates
to
accelerate
top-line
growth,
it
will
need
to
do
so
with
a
better,
more
efficient
architecture,
which
requires
continued
reinvestment
in
R&D.
However,
high
R&D
reinvestment
is
inconsistent
with
the
55%
long-term
operating
margin
needed
to
justify
the
current
$140
share
price,
which
implies
a
forward
P/E
ratio
of
88,
nearly
double
that
of
peers
at
47.
•
A
$140
share
price
would
require
Arm
to
quintuple
its
royalty
rates
in
just
eight
years
(an
8.5%
blended
rate
in
2030
compared
with
1.7%
in
2022)
and
grow
at
much
higher
rates
than
the
semiconductor
market
for
two
decades.
This
proposition
is
too
aggressive
and
would
encourage
customers
to
look
for
alternatives,
in
our
view.
•
Our
$57
fair
value
estimate
addresses
this
paradox.
It
assumes
Arm
will
need
to
invest
$15
billion
in
R&D
in
the
next
seven
years,
or
33%
of
revenue
on
average,
to
reach
a
5%
blended
royalty
rate
by
2030
and
6%
in
2033.
This
will
result
in
a
17%
revenue
CAGR
and
a
44%
terminal
GAAP
operating
margin
in
the
next
decade.
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