Growth stocks usually don't look like bargains on the surface. Arm Holdings(NASDAQ: ARM) and Reddit(NYSE: RDDT) are certainly pricey, but both have unique advantages that bode well for the future. Arm's technology is entrenched and pervasive, while Reddit has emerged as a source of reliable information for internet users.
Both stocks could be volatile, but Arm and Reddit should be on every growth investor's radar.
Pervasive technology
Technology from Arm Holdings is everywhere. The Arm architecture lies at the heart of chips that power smartphones, Internet of Things products, smart TVs, embedded devices, in-vehicle infotainment systems, and advanced driver-assistance systems. The company doesn't make its own chips but rather licenses its architecture and building blocks to chip designers.
Shares of Arm have surged since the company was taken public in 2023, more than tripling from its initial public offering (IPO) price. The stock is certainly expensive relative to standard valuation metrics. Based on the average analyst estimate for fiscal 2025 earnings, Arm shares trade at a price-to-earnings ratio over 100.
While a lofty valuation does introduce risk, two things can drive Arm's profits much higher in the years to come. First, Arm is making headway in markets such as server central processing units (CPUs) and artificial intelligence (AI)-enabled chips. Arm's royalty revenue is tied to the value of the chips using its technology, so a high-powered server CPU with many CPU cores is more lucrative than the smartphone chips that have been the company's bread and butter for years.
Second, Arm is working on boosting its royalty rates. The company kicked off an initiative in 2019 to generate an additional $1 billion in annual revenue through higher royalty rates. Analysts expect Arm to produce a bit less than $4 billion in revenue during fiscal 2025, so that extra $1 billion would represent a substantial increase.
Because Arm's technology is so pervasive, the company has incredible pricing power. Even if a company like Apple wanted to move away from Arm, it would take years of effort to do so and likely wouldn't be worth the pain.
Since Arm stock is so richly valued, it's likely to be volatile in the short run. However, the company has ample opportunities to greatly increase its earnings in the long run.
A useful social network
When I need to search for something on Alphabet's Google, I often find myself tacking on the word "Reddit" at the end of the search. This is particularly useful for things like product recommendations since Google's results are often littered with ads and content meant to get clicks rather than be genuinely useful.
This is the core investment thesis for Reddit, a social network that's very different from Facebook, Instagram, and all the others. Reddit is useful, and people use it to find reliable information about products and services. Reddit has the potential to be an advertiser's dream, although there's still plenty of work left to do on the monetization front.
Reddit generated $348.4 million in revenue during the third quarter of 2024, which works out to $3.58 per daily active unique user. Revenue is growing strongly as Reddit attracts more users and improves monetization. Revenue was up 68% year over year, daily active unique users grew by 47% year over year, and revenue per unique user was up 14% year over year. The company noted in its shareholder letter that "Reddit" was the sixth-most Googled word in the U.S. in 2024.
Reddit has room to increase its revenue per daily active user enormously in the coming years. For comparison, Meta generated more than $12 in revenue during the third quarter from each of its more than 3 billion daily active users. The challenge will be maintaining Reddit's appeal while increasing the number of ads. Too many ads could drive users away.
Reddit is already valued at over $30 billion, which puts the price-to-sales ratio based on analyst estimates for 2024 at about 25. That's pricey, but Reddit has the potential to grow sales rapidly over the next few years as it draws in more users and improves monetization. Volatility should be expected, but Reddit looks like a promising growth stock for long-term investors.
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Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. Randi Zuckerberg, a former director of market development and spokeswoman for Facebook and sister to Meta Platforms CEO Mark Zuckerberg, is a member of The Motley Fool's board of directors. Timothy Green has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Alphabet, Apple, and Meta Platforms. The Motley Fool has a disclosure policy.
