Can ARM Fly Any Higher?

Processor architect ARM Holdings (Nasdaq: ARMH  ) is soaring today. The company reported a stellar fourth quarter early this morning, and the stock is up by more than 7% as a result.

Those shares have now tripled over the past year, and they're trading at a vertigo-inducing 97 times trailing earnings. Is it time to take your profits and get out of this red-hot stock?

That would be a gutsy call to make. ARM's results are not just improving, but accelerating. Based on the company's dominance in the exploding smartphone and tablet markets, ARM saw earnings per share jumping by 62% year over year, on 28% higher sales. Gross margins were always fantastic for this intellectual-property business, but they crept even higher this quarter, now sitting at 94.2%.

It's an extremely profitable business model, doing processor research, then leaving the dirty work of manufacturing and selling actual processors to a wide range of license buyers. ARM held up NVIDIA (Nasdaq: NVDA  ) as an early adopter of next-generation chip architectures, but the customer list ranges from chip giants Texas Instruments (NYSE: TXN  ) and Marvell Technology Group (Nasdaq: MRVL  ) to gadget designers Samsung and Apple (Nasdaq: AAPL  ) , who also create ARM processors of their own.

Since some of these license agreements are made on a long-term basis, part of the sales are recorded as deferred revenues. That backlog just grew by 82% year-over-year on the company's balance sheet, significantly outpacing standard sales growth. In other words, growth is guaranteed to continue for at least a few more quarters.

The stock is still very richly valued, and most of the good news on the table should be priced in by now. But you'd be crazy to short a stock on this kind of rampage, and short interest is in fact very low, despite the nosebleed valuation.

A more proactive -- and sane -- anti-ARM strategy might involve investing in up-and-coming competitor MIPS Technologies (Nasdaq: MIPS  ) and its much more reasonable price-to-earnings ratio of 28 times trailing earnings. But 25% of that stock was sold short three weeks ago. Go figure.

Does ARM have any rocket fuel left in its tanks, or are you better off elsewhere? Discuss in the comments below.

Fool contributor Anders Bylund holds no position in any of the companies discussed here. Apple and NVIDIA are Motley Fool Stock Advisor selections. The Fool has written puts on Apple. The Fool owns shares of Apple, Marvell Technology Group, and Texas Instruments. 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. You can check out Anders' holdings and a concise bio if you like, and The Motley Fool is investors writing for investors.


Read/Post Comments (3) | Recommend This Article (12)

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  • Report this Comment On February 01, 2011, at 2:22 PM, turkeybird wrote:

    Not about to take profits here, solid growing backlogs, improving margins and product expansions should power this stock for several more quarters as competition heats up.

    Mips is over sold and appears ready again to move higher. I am a buyer here.

    TQNT is another bright spot with good growth opportunities. I am a buyer here.

    As one can see I am bullish here as long as the consumer tries to keep up with the high tech advances. NVDA is also looking more appealing.

  • Report this Comment On February 01, 2011, at 3:19 PM, mattern1 wrote:

    re:p/e of 91: in british pence, arm.l is 547.5 and latest ttm earnings are 9.36. we get p/e of 58.5. also earnings were up 71% yoy not 62%!

  • Report this Comment On February 02, 2011, at 2:33 PM, TMFRhino wrote:

    Mattern,

    http://ir.arm.com/phoenix.zhtml?c=197211&p=irol-newsArti...

    Fiscal year earnings jumped 71%. On a year-over-year basis it was a 62% jump. Also, if you want to use normalized earnings, you can arrive at that P/E. However, per IFRS, their earnings were 6.36 pence last year. That's why you'll see similar P/E ratios on Yahoo, Morningstar, whatever data source you want to use.

    -Eric

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