Should I Buy ARM Holdings?


LONDON -- It's time to go shopping for shares again, but where to start? There are loads of great stocks to choose from, and I've got my wallet out. Can ARM Holdings continue to bag amazing returns?

Entry point
The relentless march of the ARM Holdings share price has been reversed in recent weeks. Not by much, I'm afraid, but sufficient for me to ask, "Should I Buy ARM Holdings?"

If you had bought this Cambridge-based microchip maker a decade or so ago, you would have a 20-bagger on your hands today. That means ARM Holdings isn't cheap, but this is a stock that has been rewriting the rules on valuation. I decided it was too expensive five years ago, but it's up 949% since then. I also snubbed it three years ago; since then it's up 287%.

Micro chips, macro profits
Its explosive growth continues apace. Revenue grew 17% in 2012 to 577 million pounds, including a 21% leap in the fourth quarter. Pre-tax profits rose 20% to 276.5 million pounds. ARM's processor royalty outperformed the semiconductor market average by nearly 20%. Its processors are used as the main central processing unit in a host of mobiles and handheld devices, with Apple, Nintendo, Nokia, Samsung and Sony Ericsson among its customers. ARM signed licenses for 36 processors in the fourth quarter alone, which will shortly appear in a smartphone or mobile computers near you, as well as medical devices and microcontrollers.

ARM's share price rose 60% in the past six months alone. That share price slip I mentioned? A small drop of 5.5% since hitting its 52-week high of 9.71 poundsin early March. Today, you can buy it for 9.18 pounds. That's hardly the buying opportunity of a lifetime, but be grateful for small blessings.

Cheap as chips? Not likely.
The question every investor asks is whether the success story can continue. Trading at more than 60 times earnings, four times more than traditional fair value, there is scope for plenty of downside. It operates in a competitive fast-moving market, with rivals such as Intel targeting its core market of smartphones and tablets. One slip could send the share price spiralling. As could any further slippage from its most high-profile customer, Apple. The imminent departure of long-serving chief executive Warren East briefly unsettled investors, although his internal replacement, ARM president Simon Segars, has cheered them up by vowing to retain the company's independence.

Brokers still admire this microchip marvel. Bank of America has just confirmed its "buy" rating after claiming the earnings potential of ARM's big.LITTLE Processing energy-saving technology had been "underappreciated," and will increasingly spread from top-end phones to the cheaper end of the market. Like me, the broker has been tempted by recent share price slip.

Mind games
You won't be surprised to see that income has been trampled in the dash for growth. ARM yields just 0.5%, covered 3.3 times, despite management hiking the dividend 29% to 4.5 pence a share in 2012 (it was just 2.2 pence four years ago). A 36% operating margin is rather nifty. So is forecast earnings-per-share growth of 26% this year and 29% in 2014. Because it specializes in intellectual property, selling its ideas rather than physically manufacturing them, ARM employs just 2,392 people, which limits its cost base. Give me mind over muscle any time. This little-big company will cost you an ARM and a leg, but look what you get for your money.

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Harvey Jones has no position in any stocks mentioned. The Motley Fool recommends Apple and Intel. The Motley Fool owns shares of Apple, Bank of America, and Intel. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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