How ARM Holdings Measures Up as a GARP Investment

LONDON -- A popular way to dig out reasonably priced stocks with robust growth potential is through the "Growth at a Reasonable Price," or GARP, strategy. This theory uses the P/E-to-growth ratio to show how a share's price measures up in relation to its near-term growth prospects -- a reading below one is generally considered decent value for money.

Today I am looking at ARM Holdings (LSE: ARM  ) (NASDAQ: ARMH  ) to see how whether it makes a good GARP share.

What are ARM Holdings' earnings expected to do?

 

2013

2014

EPS growth

37%

24%

P/E ratio

47.7

38.6

PEG ratio

1.3

1.6

Source: Digital Look.

ARM Holdings has posted chunky earnings-per-share growth in each of the last three years, and City analysts expect this to remain the trend for both this year and next.

The semiconductor specialists carry a PEG ratio of more than one for 2013 and 2014, while its P/E readout for this period is also massively higher than a classification of 10. A reading below this figure is generally considered excellent value for money.

Does ARM Holdings provide decent value against its rivals?

 

FTSE 100

Technology Hardware and Equipment

Prospective P/E Ratio

17.1

24.5

Prospective PEG ratio

4.8

0.7

Source: Digital Look.

ARM Holdings beats the FTSE 100 in terms of prospective PEG ratio -- the ultimate GARP metric -- although it does fall behind the index when comparing its P/E rating. Meanwhile, the company significantly lags its sector peers on both counts. Indeed, its rivals can be considered classic growth selections with an average PEG projection of less than one.

In my opinion, ARM Holdings' stratospheric share-price rise in recent years -- prices have leapt 95% in the past year alone -- has left the company looking excessively expensive in relation to its growth prospects and in severe danger of a price collapse.

Promising, if overpriced
ARM Holdings is undoubtedly a massive player in the creation of semiconductors. The company -- which generates revenue through creating and licensing intellectual property -- has seen profit surge in recent years, owing to the explosion in smartphone and tablet PC demand, for which it is a key component-builder for many of the world's largest manufacturers.

And rising technology demand is set to keep turnover rolling higher. ARM Holdings estimates that the number of Internet-connected devices will triple to 30 billion by 2020, pushed by a one-third increase in the number of middle-class consumers to 3.3 billion over the period.

However, the company is likely to experience increasing competition in the chip market in coming years, with Intel in particular inking deals with tech giants such as Motorola and Lenovo to use its platform. Indeed, Liberum Capital notes that phone and tablet leviathan Samsung's upcoming Galaxy Tab 3 10.1 is tipped to be using an Intel processor and would represent the first Android product from Samsung incorporating an Intel processor, rather than an ARM equivalent.

So even though ARM Holdings looks set to remain a forerunner in the semiconductor market for some time to come, I would argue that potential medium-term earnings growth already appears locked into the price. And in the long term, the onset of heavy competition could put revenue under pressure further down the line.

The expert's guide for intelligent investors
Although ARM Holdings looks far too expensive in my opinion, this newly updated special report highlights a host of other FTSE winners identified by ace fund-manager Neil Woodford. Woodford, head of U.K. Equities at Invesco Perpetual, has more than 30 years' experience in the industry and boasts an exceptional track record when it comes to selecting stock market stars. The report, compiled by The Motley Fool's crack team of analysts, is totally free and comes with no further obligation. Click here now to download your copy.


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