Prediction: This artificial intelligence (AI) stock will outperform Nvidia over the next decade

A few years ago, semiconductor specialist Nvidia tried to acquire a little-known company called Arm stocks (ARM 6.84%).

Unfortunately for Nvidia, the company abandoned the deal as there appeared to be no end in sight to the lengthy legal battles surrounding antitrust concerns. After the failed takeover, Arm pursued an initial public offering (IPO) – with success Nasdaq last September.

Since the IPO, Arm shares have risen 138% on the back of the artificial intelligence (AI) movement. But even after such a meteoric rise, I see much better days ahead for Arm. In fact, I think Arm stock will significantly outperform Nvidia over the next decade.

Below, I’ll detail why I’m so bullish on Arm and explain how increasing competition in the chip space could trigger Nvidia’s first tough battle in quite some time.

Why Arm stock could outperform Nvidia

The semiconductor industry consists of many different components. Not all chip manufacturers make graphics processing units (GPUs) like Nvidia or Advanced micro devices. There are far more applications for chips, and Arm dominates a pretty single market area.

At its core, Arm designs chip architectures for mobile devices, consumer electronics, data center networking devices and other Internet of Things (IoT) devices. The company makes money by licensing its intellectual property (IP) and earns a royalty based on its various architectures.

As shown in the graphic above, Arm’s architecture is deeply embedded in various applications. This gives the company an enviable level of flexibility when it comes to new chips coming to market in the future. In other words, companies that use Arm’s architecture are less likely to develop a new hardware and software system that does not conform to Arm’s architecture.

Additionally, the slide above shows that Arm’s market share has increased across the board over the past two years. With that in mind, I think the company is well-positioned to continue benefiting from new chip-based devices since Arm’s intellectual property is already used on so many devices around the world.

For this reason, I consider Arm to be less vulnerable to competitive forces in the chip space compared to competitors like Nvidia.

Why Nvidia’s best days may be in the rearview mirror

Like Arm, Nvidia also has a strong presence in its core market. The company’s A100 and H100 chipsets have helped Nvidia capture an estimated 88% of the GPU market.

However, I see some obvious risks that could threaten Nvidia over the next few years, and it wouldn’t surprise me if the company started losing market share.

First, companies including Microsoft, alphabet, Tesla, AmazonAnd Metaplatforms are all investing in their own customized chip designs. In addition, these companies have been called Nvidia’s largest customers by Wall Street analysts – they generate almost half of the company’s revenue.

While one could argue that more competition is a good thing for Nvidia, I don’t see it that way in this case. These companies will likely remain Nvidia customers for a few years, but introducing their own hardware could prove to be a bargaining chip in the long run.

What I mean by this is that more GPUs on the market will likely weaken Nvidia’s pricing power. In turn, I believe Nvidia’s revenue and profit growth could slow dramatically – a dynamic that growth investors don’t want to see.

But increasing competition isn’t the only risk Nvidia faces. Given the company’s near-monopoly position, there is a possibility that the Department of Justice (DOJ) could investigate Nvidia’s business practices and force the company to loosen its ecosystem.

Given the many uncertainties surrounding Nvidia’s future, I’m skeptical that the stock is a given at this point.

Is Arm stock a buy right now?

There have been many periods of expansion and decline in Arm’s trading activities. But with a forward price-to-earnings (P/E) ratio of 96, it’s hard to say the stock is cheap.

The forward P/E ratio of the S&P 500 is about 23, less than a quarter of Arm.

ARM PE Ratio (Forward) data from YCharts.

Here’s how I think about it: The market is clearly putting a premium on Arm stock, and for good reason. I think there are two key themes to unravel.

On a macroeconomic level, AI appears to be here for the long haul, and the biggest tech companies are committed to spending billions on future artificial intelligence initiatives. While spending will vary from year to year, the long-term tailwinds of AI should bode well for Arm.

At a company-specific level, Arm’s unique position in the chip space and its lucrative business model suggest that the company’s growth will remain robust over time.

For these reasons, I see Arm as the superior investment over Nvidia over the next decade. While the stock isn’t a bargain, I think it still represents a compelling opportunity for long-term investors.