Are You Mad to Hold ARM Holdings?

If you bought shares in FTSE 100 tech star ARM Holdings (LSE: ARM.L  ) (Nasdaq: ARMH  ) when it hit record lows of around 50 pence in early 2003, you could now be sitting on a 10-bagging gain. To add icing to an already tasty cake, your dividend yield on cost would have reached almost 7% last year.

For investors like you, ARM shares are the nearest thing possible to a personal gold mine and you are unlikely to want to sell them, unless you want to cash in some of your capital gains.

For more recent investors, holding ARM shares could be a completely different story, as I'll explain.

Timing is everything
ARM is by no means an ideal share for everyone. Anyone who was unlucky enough to buy during the 2000 boom, when ARM shares peaked at 986 pence, is likely to still be sitting on a thumping loss, given today's share price of 582 pence.

On the other hand, anyone who has bought ARM shares over the last three years and enjoyed rapid profits might want to think about the reality of owning shares in a company that currently has a price-to-earnings ratio of 46 -- the highest in the FTSE 100. By way of comparison, the FTSE 100 average is currently 16.

Short, sharp shock
Shareholders in upmarket fashion retailer Burberry Group (LSE: BRBY.L  ) received a rude awakening last week when the value of their shares plunged by 21%. The trigger for this was a quarterly sales update announcing a 6% increase in retail sales over the last quarter. Although these were new stores sales -- like-for-like sales remained flat -- the figures were pretty respectable by most standards.

The problem was that the company described the external environment as "challenging" and said that sales growth was "slowing". Those few words were all that it took to drop Burberry's P/E rating from 21 to 17, almost level with the FTSE 100 average.

Burberry's price drop won't matter so much to older shareholders, as its share price is still 407% higher than it was in 2002. However, recent shareholders may have taken a painful hit.

Could it happen to ARM?
ARM has been riding high on the smartphone boom for the last three years -- and I suspect that growth will continue for a little longer. But think back to the 1990s and the rapid growth of the PC market. Intel shares rose in value by about 20 times during the 1990s -- yet today they trade at much the same level they did in late 1999.

My suspicion is that something similar will happen with ARM. At some point, its technology will mature and something else will take its place, leaving ARM to become a more typical large-cap share, delivering profits, dividends and moderate growth.

The problem is that this transition could be painful for ARM's shareholders, as it is likely to involve a substantial re-rating of its share price to more normal levels -- perhaps less than 20 times earnings. Intel today trades at a P/E of just 9.9.

Making big money
Early shareholders in ARM are now reaping the rewards of their patience and careful research. They can afford to sit back and enjoy their dividend income and don't need to worry if ARM's share price drops by 10% tomorrow.

Identifying potential success stories early and then having the confidence to commit to them over many years is one of the secrets of making big gains from investing in shares.

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Further investment opportunities:

Roland Head does not own any of the shares mentioned in this article. The Motley Fool has recommended shares in Burberry and Intel. The Motley Fool owns shares of Intel. The Motley Fool has a disclosure policy.
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