2 AI Stocks to Consider Before Their Potential Surge in 2025

The U.S. stock market enjoyed another remarkable year recently. The broad market index, S&P 500 (^GSPC 0.16%), saw a return of 23%, while the Dow Jones Industrial Average (^DJI 0.25%) rose by 13%. The tech-heavy Nasdaq Composite (^IXIC -0.06%) experienced an impressive increase of 29% in 2024.

Artificial intelligence (AI) continued to be a significant driver of investment enthusiasm in the past year, a trend that is predicted to continue in 2025. Notably, two analysts from Morgan Stanley have highlighted potential strong performers in the AI sector: Datadog (DDOG 0.34%) and Arm Holdings (ARM 0.57%). They predict substantial returns for these companies as AI technology enhances their businesses.

• Sanjit Singh from Morgan Stanley has set a bullish price target for Datadog at $205 per share, indicating a potential upside of 45% from its current price of $141.
• Similarly, Lee Simpson has projected Arm's target price at $300 per share, suggesting an impressive 108% upside from its current level of $144.

In this article, we will delve into the specifics of Datadog and Arm to assess their growth prospects.

Datadog: 45% Upside Potential

Datadog specializes in observability software, offering a platform equipped with multiple tools that assist businesses in monitoring their applications and infrastructure. By utilizing Datadog's services, companies can detect and rectify performance issues while fostering improved collaboration between development and operations teams.

According to Gartner, Datadog has been recognized as a leader in the field of observability and digital experience monitoring software. The market for these services is expected to grow at an annual rate of 12% through 2027, as businesses increasingly migrate to the cloud and undergo digital transformations. AI is anticipated to be a crucial contributor to this growth, and Datadog is actively launching new products to cater to this demand.

In the previous year, Datadog rolled out a product called LLM Observability, designed for developers to monitor generative AI applications and the underlying large language models (LLMs). CEO Olivier Pomel reported that hundreds of clients are currently utilizing this product. AI-driven clients contributed an additional 4 percentage points to revenue growth in the last quarter, a notable rise from 2 percentage points in the same period the previous year.

The consensus on Wall Street holds that Datadog's adjusted earnings will grow at a rate of 13% annually up to 2026. Given this forecast, Datadog's current valuation of 75 times its adjusted earnings may seem elevated. Consequently, Morgan Stanley's bullish target is grounded on an expectation of revenue growth at 28% per year through 2026, projecting earnings growth that surpasses the consensus.

While this scenario appears achievable, especially as Datadog has consistently exceeded earnings expectations over the past 12 quarters, investors should remain cautious. A significant increase in valuation would be necessary to achieve the anticipated 45% return in 2025. Nonetheless, Datadog remains an impressive company with potential for solid growth, making it a worthwhile addition for long-term investors, particularly when buying opportunities arise.

Arm Holdings: 108% Upside Potential

Arm is in the business of designing CPU architectures and selling instruction sets to various companies, enabling them to develop chips tailored for specific applications across mobile devices, automotive systems, industrial sensors, and data centers. Arm also offers development tools that aid engineers in configuring systems and programmers in creating applications.

Arm's business model allows companies to reduce research and development expenses linked to chip design while still maintaining the ability to create custom processors. Known for its power efficiency, Arm commands over 99% of the smartphone market and has also become increasingly attractive for data centers looking to optimize energy use, especially for AI-related workloads.

In the past two years, Arm made significant gains in the cloud computing market, capturing an additional six percentage points of market share due to the improved power of its chips. Currently, ten of the largest cloud service providers, including Amazon, Microsoft, and Alphabet, are developing chips based on Arm architecture for their data centers, positioning the company favorably for increased share growth as demand for efficient AI infrastructure rises.

Wall Street estimates that Arm's adjusted earnings will rise at 33% annually through fiscal 2027, which wraps up in March 2027. This forecast makes Arm's current valuation of 104 times adjusted earnings appear high. Morgan Stanley's optimistic target relies on an assumption of much faster growth fueled by AI server chip demand.

While it's feasible for Arm to exceed expectations based on past performance, a 100% return this year would necessitate substantial earning growth or an even steeper valuation increase, and caution is warranted before anticipating such outcomes.

That said, Arm presents a solid long-term investment given its innovative business approach. Investors might find more appealing opportunities in the future, but those interested in acquiring shares could consider starting with a modest position now.

Note: The views and opinions expressed above are those of the individual authors and do not necessarily reflect the official position of any organization.

stocks, AI, investment