Shares of artificial intelligence (AI) companies that some investors see as the “next Nvidia” could jump 130%, according to a Wall Street analyst

Nvidia is one of the biggest beneficiaries of the artificial intelligence (AI) boom due to its dominance in data center accelerators. The company’s shares are up 750% since ChatGPT launched in November 2022 and remain a staple AI stock in many portfolios. However, Nvidia’s market capitalization is just under $3 trillion, so the chances of similar returns in the future are slim.

As a result, some investors have shifted their attention to Arm Holdings (ARM -15.72%) in hopes of finding the “next Nvidia.” Arm shares have more than doubled since the company went public in September 2023, but Lee Simpson in Morgan Stanley believes the momentum can continue. His $300 per share price target implies a 130% upside from the current share price of $129.

Here’s what investors need to know about Arm.

Arm has an attractive business model and is gaining share in key markets

Arm designs central processing unit (CPU) architectures and licenses intellectual property (IP) to other companies that use the IP to create custom chips. The company also supports its customers with development tools and services that streamline the engineering of hardware and software products. It earns money from licensing fees and royalties upstream of the chip, so it benefits when popular products (such as iPhones) are built using its IP.

Each processor has an instruction set architecture that defines how the hardware and software interact. The Arm architecture has historically been associated with power efficiency, while the x86 architecture has been Intel AND AMD is associated with computing performance. As a result, Arm chips are widely used in battery-powered devices. For example, the company has a 99% share of the smartphone market and a 67% share of the other mobile device market.

Meanwhile, Intel and AMD processors have historically been the industry standard in consumer electronics and cloud computing. But Arm is taking share in both end markets with its more powerful chips. Over the past two years, its share of the cloud processor market has risen 6 percentage points to 15%. Its share of the consumer electronics processor market has risen 6 percentage points to 30%.

Additionally, Arm IP technology has been used in many popular products. Apple AND Microsoft introduced personal computers (PCs) equipped with Arm-based processors, Amazon Internet services, AlphabetGoogle Cloud and Meta Platforms developed Arm-based processors for their data center servers. Nvidia also introduced an Arm-based processor for data centers, specifically designed for artificial intelligence (AI).

In short, Arm has an attractive business model. It gives customers the flexibility to build custom chips, but still reduces time to market and R&D (research and development costs) compared to semiconductors designed from scratch. As a result, Arm processors are ubiquitous in smartphones and other mobile devices, and the company is gaining share in key end markets like cloud computing and consumer electronics.

Arm’s dominance in the mobile market means the company should reap the benefits as more AI workloads run on edge devices

Morgan Stanley believes Arm is particularly well-positioned to monetize edge AI, or AI workloads that run on end-user devices like PCs and smartphones. The opposite of edge computing is cloud computing, where information is sent back to centralized data centers for processing.

Cloud computing has the advantage of more powerful chips, but the disadvantage is application latency. Edge computing reduces latency by processing data at the device level, rather than sending it over the internet to and from data centers.

Arm-based processors are already the industry standard in smartphones and other mobile devices, and the company’s chips are becoming increasingly popular in PCs, so Morgan Stanley is making a very compelling case. In fact, there’s already evidence that Arm is using edge AI. Arm-based processors will power Apple Intelligence in iPhones and MacBooks, as well as some of the Copilot+ computers recently introduced by Microsoft and other OEMs like Dell Technologies AND Hewlett-PackardCopilot+ computers are a category of laptops designed with artificial intelligence in mind.

CEO Rene Haas recently told Reuters that Arm could take over 50% of the Windows PC market share within five years. That would represent a significant shakeup for the PC industry, given that Arm-based processors accounted for less than 15% of PC processor shipments last year, according to Counterpoint Research.

Arm shares trade at a high valuation relative to future growth trajectory

Wall Street expects Arm to grow adjusted earnings by 29% annually through fiscal 2027 (ending March 2027). However, Morgan Stanley has provided a base case and a bull case scenario in which earnings grow by 46% annually and 69% annually, respectively. The base case corresponds to a fair value of $190 per share, while the bull case corresponds to a fair value of $300 per share.

Importantly, Morgan Stanley’s price targets are the highest on Wall Street, so other analysts are more bearish. Arm has a median price target of $125 per share, which implies a 3% downside from the current share price of $129.

I doubt Arm’s earnings will grow much faster than Wall Street consensus in the coming years. The company’s forecasts suggest 22% earnings growth in fiscal 2025 (ending March 2025), which is actually below consensus. What’s more, that forecast makes the current valuation of 94 times adjusted earnings look expensive.

Arm has an attractive business model, and its strong presence in mobile devices gives the company significant growth potential. However, I doubt the stock will deliver triple-digit returns next year.

John Mackey, former CEO of Whole Foods Market, a subsidiary of Amazon, is a member of The Motley Fool’s board. Suzanne Frey, chief executive officer at Alphabet, is a member of The Motley Fool’s board. Randi Zuckerberg, former chief market development officer and spokeswoman for Facebook and sister of Meta Platforms CEO Mark Zuckerberg, is a member of The Motley Fool’s board. Trevor Jennewine holds positions in Amazon and Nvidia. The Motley Fool has positions in and recommends Advanced Micro Devices, Alphabet, Amazon, Apple, Meta Platforms, Microsoft, and Nvidia. The Motley Fool recommends Intel and recommends the following options: long January 2025 $45 call options on Intel, long January 2026 $395 call options on Microsoft, short August 2024 $35 call options on Intel, and short January 2026 $405 call options on Microsoft. The Motley Fool has a disclosure policy.