Own ARM stock? This Is the 1 Thing to Watch Now

Key Points

• Arm has emerged as an AI winner since its IPO in 2023.

• The company has a unique business model, licensing its CPU designs and earning royalty revenue.

• Its new Compute Subsystems (CSS) product appears to be growing rapidly.

• 10 stocks we like better than Arm Holdings ›

Arm Holdings (NASDAQ: ARM) has emerged as one of the top semiconductor and artificial intelligence (AI) stocks on the market today. After going public in 2023, the stock soared as investors realized it had more exposure to AI than they initially believed. Today, Arm stock is expensive, trading at a price-to-sales ratio of 38, but it also has a robust set of competitive advantages that set it apart from any other stock in its industry.

There are two things that are unique about Arm. First, its business model is distinct from any other tech company. Rather than designing chips, the company licenses its CPU architecture to companies like Apple and Nvidia. It earns revenue when it sells those licenses, and it earns royalty revenue when the products containing those licenses are sold. That gives the company a more resilient revenue stream than most semiconductor companies, and the royalties it earns tend to last for years. It's also led to high margins.

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The other unique component of Arm's business is its CPU architecture, which is known for being more power-efficient than the competing x86 alternative made by Intel and AMD. That's led to Arm gaining essentially universal adoption in the smartphone market with 99% market share, and it's also made it a popular choice for the rapidly growing data center market, where efficiency is also prized due to the extraordinary energy demand to run AI models.

Arm just finished its fiscal 2025 year, but there is one product line in particular that investors should watch as it kicks off a new fiscal year.

Image source: Getty Images.

Arm Compute Subsystems

Arm has historically licensed its CPU architecture, but its latest iteration, Compute Subsystems (CSS), takes that strategy one step further.

Arm subsystems are pre-verified and pre-integrated configurations of its technology that help accelerate the development of Arm-based systems. Last year, the company introduced its first CSS targeted at the infrastructure space, supporting AI and data centers, and the company is seeing rapid adoption of CSS.

Growth of CSS not only strengthens its business model by giving customers a more complete model, but it also brings in more money for Arm as royalty rates for CSS are about double what they are for v9, its latest CPU design.

In the fourth quarter, it sold its first license for automotive CSS, tapping into another massive market for the company. CSS is especially valuable to the company because it accelerates time-to-market for Arm's customers, allowing them to bring a product to market faster, creating more value for them, which means Arm can collect revenue faster. The royalty rates are significantly higher as well, allowing the company to earn more money without needing growth in the overall device market.

Arm is also moving into other new territory like ASIC custom chips, showing it's expanding its addressable market in other ways.

Where Arm stands today

Arm stock fell in the fiscal fourth quarter, reported back in May, after management didn't give guidance for the next fiscal year. That was due to the more general uncertainty around tariffs, and the fact that Arm's customers have also not given guidance. First-quarter guidance called for roughly 13% growth, though its quarter-to-quarter growth rate is volatile due to the nature of licensing deals.

However, that uncertainty shouldn't be mistaken for weakness as the company's momentum in AI remains strong, especially as it moves into new product lines like CSS and ASIC.

Compute Subsystems could hold the key for the company's growth in the coming years, especially as AI drives growing demand for designs. With double the royalty rate and a faster time to market, CSS could drive the next leg of growth for the company.

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Jeremy Bowman has positions in Arm Holdings and Nvidia. The Motley Fool has positions in and recommends Apple and Nvidia. The Motley Fool has a disclosure policy.