The semiconductor space has had its fair share of big winners this year, with Arm Holdings(NASDAQ: ARM) among them. Its stock price is up nearly 79% in 2024 as of this writing.
With this having been a stellar year for the company, the question now turns to whether the stock is a buy heading into 2025. Let's see if investors should consider Arm after the stock's run-up this year.
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Arm has a great business model
When looking at Arm Holdings as an investment, one of the first things that stands out is the company's business model. Unlike a company such as Nvidia that designs and sells chips, Arm generates its revenue from licensing its technology and more recently by offering subscriptions for its use.
With its licensing business, the company receives an up-front fee that permits customers to design chips using its technology -- and more importantly, it gets a royalty from the fee-paying company on each one of these chips that is shipped. At the time of its initial public offering in September 2023, the company said nearly half its royalty revenue was coming from products that were initially released between 1990 and 2012.
As such, its royalty revenue tends to have what is often referred to as a long tail, meaning it continues to generate revenue well into the future after a design win.
Arm also gets higher royalties when customers use its newest, more advanced technology. For its latest V9 technology, the company said on average it has been getting more than double the royalty rates of its earlier V8 version on a like-for-like basis. Last quarter, the company said that about 25% of its royalty revenue was coming from V9-based chips.
More recently, the company has turned to offering customers subscription services for access to its intellectual property (IP). It has two subscription services: Arm Total Access and Arm Flexible Access.
The former gives customers access to a broad set of technology, including its most advanced CPUs (central processing units) and NPUs (neural processing units), while the latter lets customers test and experiment with its IP for free before paying a royalty based on production. Arm Flexible Access is generally designed for smaller start-ups and does not include its new technology.
Last quarter, it added six new Arm Total Access customers, bringing the total to 39. It ended the period with 269 customers in its Arm Flexible Access program.
Both of Arm's revenue streams -- licenses and subscriptions -- come with very high gross margins that tend to drop directly to the bottom line as profit.
Image source: Getty Images.
A smartphone leader and emerging uses
The most important market for Arm is smartphones, where the company says its technology is incorporated into 99% of all smartphones. It is looking to benefit in this market from an upgrade cycle in smartphones spurred by artificial intelligence (AI), which needs the latest and greatest technology to run on.
It's also profiting as more smartphones use its V9 platform, which as mentioned above carries much higher royalties. Apple's new A18 chip in the iPhone 16 is based on its V9 architecture, while iPhone 15 models used its A16 chips and A17 chips that were based on its older V8 architecture.
As such, Arm should gain from any increase in iPhone sales as well as higher royalties.
The company is also starting to benefit from AI. Currently, Arm-based CPUs are being combined with Nvidia's GPUs to form superchips used in data centers. There are reports that the company also plans to develop its own AI chips.
It is looking to move into a number of other areas, including the automotive sector and the Internet of Things (IoT). One big focus is taking significant share in the Windows-based personal computer market as companies move toward AI-enabled PCs. The company had long ago gained 100% share with Apple's Macs, and earlier this year it said it was looking for a 50% market share in Windows-based PCs within the next five years.
Is Arm stock a buy?
From a valuation standpoint, Arm stock is not cheap, trading at a forward price-to-earnings ratio (P/E) over 65 based on fiscal 2026 analyst estimates.
However, it has one of the most attractive business models in the semiconductor sector, as well as a big opportunity in the smartphone, PC, and AI spaces. As such, I think Arm Holdings is a solid buy to consider at current price levels.
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Geoffrey Seiler has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Apple and Nvidia. The Motley Fool has a disclosure policy.
