Why Artificial Intelligence (AI) Stock Arm Holdings Slumped Today

Shares of Arm Holdings (NASDAQ: ARM) stumbling out of the gate on Monday and never recovered, falling as much as 6.9%. As of 2:16 p.m. ET, the stock was still down 4.9%.

The catalyst that sent the chipmaker and artificial intelligence (AI) specialist lower was the dour outlook of one Wall Street analyst.

Getting ahead of itself?

Analysts at HSBC downgraded Arm to reduce (hold) while simultaneously increasing the firm's price target to $105, up from $100. If that logic strikes you contradictory, you're not alone. The analysts appear to have mixed feelings about Arm's future potential, which accounts for the disparity.

There seems to be some question regarding the size of the total addressable market (TAM) for AI-powered personal computers (PCs). The analysts feel demand may not be as strong as initially believed, citing feedback from rival Qualcomm and increasing competition for other chipmakers, including Intel and Advanced Micro Devices . Analysts also cited weakness in the smartphone market, which represents a sizable chunk of Arm's sales.

The potential for short-term weakness, combined with Arm's "premium" valuation, led to the downgrade.

A massive market opportunity

For investors with a long-term outlook, this downgrade is something of a nothing burger, particularly as the logic is so focused on the immediate future.

Arm's opportunity in AI is multi-pronged, so it bears noting. First, the royalty payments the company receives for its chip architecture are expected to more than double from 5% to 10% of the average selling price of the central processing units (CPUs) it designs, thanks to the more complex structure necessary to support AI. Additionally, the rate Arm receives for each core is also expected to double.

In terms of valuation, Arm's forward price/earnings-to-growth (PEG) ratio , which takes into account its impressive growth trajectory, comes in at less than 1, the standard for an undervalued stock.

Given the massive opportunity and its critical place in the AI ecosystem, Arm is well-positioned to prosper.

HSBC Holdings is an advertising partner of The Ascent, a Motley Fool company. Danny Vena has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Advanced Micro Devices and Qualcomm. The Motley Fool recommends HSBC Holdings and Intel and recommends the following options: long January 2025 $45 calls on Intel and short August 2024 $35 calls on Intel. The Motley Fool has a disclosure policy .