It takes decades to build wealth NVIDIA (NASDAQ: NVDA)Over the past year, shares have risen an astounding 165% on accelerating growth tied to heavy investments in artificial intelligence (AI) across the tech sector.
But it's not the only thing that will generate huge investment returns. Arm Holdings (Nasdaq: ARM) The company's stock price has risen by more than 120%, leaving investors in a dilemma: which AI stocks are best to hold?
It turns out one is much more likely to stick than the other. Which one is it? Here's what you need to know.
Both companies play important roles in AI
The strong momentum for both stocks highlights the important role that both companies are playing in AI. It's unclear what AI technology will look like in five or 10 years, but Nvidia and Arm Holdings will likely be at the center of it.
Nvidia's AI chips are more or less the building blocks of AI technology, and AI language models such as ChatGPT are trained in massive data centers with thousands of chips.
Nvidia's chips are purpose-built for demanding, compute-intensive applications — characteristics that make them ideal for AI, and the company has been successful in optimizing its chips and software for AI.
All of the companies investing in building these AI models are gravitating toward Nvidia, which is estimated to control 90% of the market share in AI chips. It's unclear when (or if) the company will lose its dominance in the chip market.
Arm Holdings is arguably the gold standard in computer chip design: its central processing unit (CPU) architecture powers roughly half of the world's computer chips, a footprint that includes smartphones, cars, computers and more.
Arm makes its money by charging royalties and licensing fees for each chip that uses its intellectual property, which includes Nvidia's next-generation data center CPU Grace series.
Both Nvidia and Arm Holdings will have a major say in the future of AI.
AI is already benefiting both businesses
Both companies are already seeing the impact of AI on their businesses: Nvidia and Arm are profitable, with rapid revenue growth lining their coffers.
Arm's business has proven to be more profitable. Its main expense is research and development. For every dollar of revenue, it generates about $0.70 in free cash flow. But Arm is a much smaller company than Nvidia. Its trailing 12-month revenue was just over $3.2 billion.
On the other hand, NVIDIA is not as efficient as Arm at converting revenue into cash flow, but Much more Revenue: About $80 billion in the past year.
Nvidia's ability to sell physical products at such high margins is impressive, which is why they will generate much more cash flow than Arm in the long run. More cash flow gives a company more options. Nvidia came close to acquiring Arm Holdings before it went public, but the merger fell through. Give the edge to Nvidia, which is much larger and similarly profitable.
Talking about evaluations widens the gap
Analysts are similarly optimistic about the revenue growth of both companies over the next few years. The consensus long-term forecast is for both Nvidia and Arm to grow revenue at roughly 31% annually. However, their starting valuations differ dramatically, as you can see below.
With a forward price-to-earnings ratio of half that of Arm Holdings, Nvidia shares have a margin of safety built in. Assuming growth forecasts are accurate, Nvidia is likely to perform much better.
As the saying goes, the higher a stock price is, the more it can fall. A high valuation means there is less room for things to go wrong. ARM Holdings could be performing very well as a business, and factors external to the company, like overall market volatility, could also cause the stock price to fall.
Nvidia and Arm Holdings are blue-chip tech stocks with bright futures in the AI space thanks to their competitive advantages, but given the dramatic difference in valuation, Nvidia seems like the better AI stock to buy right now.
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Justin Pope has no position in any of the stocks mentioned. The Motley Fool owns shares in and recommends Nvidia. The Motley Fool has a disclosure policy.
The post Best Artificial Intelligence Stocks: Nvidia vs. Arm Holdings was originally published by The Motley Fool.
