This AI stock could fall 50% and has an 'exaggerated artificial intelligence narrative,' Morningstar says

Published Mon, Apr 8 20247:25 PM EDT

Arm , the British semiconductor design company, has seen its share price skyrocket since reporting third-quarter earnings in February. The stock has risen by 65% this year, driven by what Morningstar calls the "AI buzzword" narrative and the company's ability to increase royalty fees after its latest chip architecture launch. Arm develops and designs the blueprints for microprocessors and counts companies like Nvidia and Apple as some of its biggest customers. The company's business model relies on licensing revenue — or royalties — for every chip its customers produce using its designs. However, Morningstar believes the current share price is overvalued and could drop by 54% to $57. ARM YTD mountain "After the company reported earnings on Feb. 7, its shares soared more than 50% and have traded close to $140 since, propelled by an exaggerated artificial intelligence narrative combined with excitement about recent increases in royalty rates after the introduction of its newest architecture, Armv9," said Morningstar analyst Javier Correonero in a note to clients on Mar. 28. AI is 'ancillary' for Arm While acknowledging that Arm is executing well and benefiting from the growth in artificial intelligence, Morningstar said that the company's AI story is "ancillary" compared to that of Nvidia, a big beneficiary of AI chip sales. The research firm does not expect Arm to experience earnings growth "anywhere close to that of Nvidia." Morningstar's price target for Arm, which the firm calls a fair value estimate, is $57 per share. This assumes a 17% annual growth rate over the next decade and a top-end profit margin of 44%. In contrast, the research firm believes the current share price implies a 22% revenue growth rate and a 55% operating profit margin. Morningstar's analyst said that while this scenario would provide a short-term boost to Arm's financials, it would create long-term risks by requiring the company to raise its royalty rate by four times in just eight years, potentially pushing customers to seek alternative and cheaper architectures. Morningstar is not alone in its bearish view. The consensus price target of 31 analysts covering Arm polled by FactSet points to a 14% downside. Arm declined to comment when contacted by CNBC Pro. The bullish view In contrast, Mizuho Securities takes a more optimistic view of Arm's long-term prospects. The research firm has raised its price target for Arm to $160, representing 28% upside from current levels. The investment bank believes the Arm's revenues will grow by 25% annually for three years from 2025, significantly higher than Morningstar and the consensus view. Mizuho Securities highlights a number of reasons for its bullish stance on Arm. "ARM remains the unquestioned leader in the mobile CPU space with > 99% market share, and we see potential for further revenue ramps as more OEMs move to v9 platforms over the next 3 years," said Mizuho analysts led by Vijay Rakesh in a note to clients on Mar. 6.